Corporate dividends mattered to Brian C. Rogers even when they were out of style.
“Three years ago, dividends were considered passe, almost a sign of corporate weakness,” said Rogers, the manager of the $11.5 billion T Rowe Price Equity Income Fund (PRFDX) fund since its inception in 1985. “Now, dividends are in vogue again.”
He said that he expects more companies to pay dividends as part of their corporate finance strategies, prompted in part by the recent tax cut, which reduced the top rate on dividends to 15%. “As investor sentiment continues improving and investors move back into stocks,” he said, “they’ll place an increasing emphasis on the income parts of their portfolio.”
As of the end of July, the companies in the fund yielded an average of 2.6%, annualized, versus 1.8% for the Standard & Poor’s 500-stock index.
To pick the approximately 115 stocks in the fund, Rogers conducts a weekly screen of about 1,000 American companies with market capitalizations of at least $2 billion.
He looks for companies with solid records of paying above-average dividends. These stocks tend to weather falling markets better than other stocks, he said, and the dividends tend to reduce price volatility.
He also searches for companies with low price-to-earnings ratios. In June, the portfolio companies traded for an average of 15.7 times projected 2003 earnings, compared with a multiple of 17.5 for the index, he said. The screens also take into account price-to-sales ratios, to help him find valuation anomalies, he said.
Based on these screens, Rogers researches about 100 to 150 companies to assess why their stock prices are cheap — and the chances for improved performance over the next two to three years.
He wants to see a strong capital structure, with low debt and high amounts of free cash flow. “We look at the company’s ability to generate adequate cash to pay dividends and management’s motivation to pay dividends,” he said.
He doesn’t automatically sell, however, when a company cuts its dividend. “By that point, investors have probably borne most of the pain,” he said. “So the question becomes, is all the bad news already reflected in the stock price? Oftentimes, it is.”
Rogers began buying shares of the TXU Corp (TXU), the utility based in Dallas, early this year and has paid $15 a share, on average, for the entire position.
The price fell to less than $11 last October from more than $50 in the spring of 2002, he said, because of “concerns over investments in generating capacity and acquisitions in Europe that they dramatically overpaid for.”
To conserve cash, the company sold its British division at a huge loss and cut its dividend in October 2002 by 80%.
But Rogers said that he believes the market overreacted and that he expects the company to surmount its difficulties. The stock now trades at $20.83, and its dividend yield is 2.4%.
Rogers called Baxter Intl (BAX), the medical products maker in Deerfield, Ill., “a growth stock that all of a sudden turned into a yield stock.” Its price fell from about $60 in early 2002 to less than $30 by year-end. The company has repeatedly reduced its earnings estimates, citing competitive pressures and pricing difficulties in its plasma business. The shares now yield about 2.1%.