Dividends: "The Sweet Spot"

02/18/2005 12:00 am EST

Focus:

Barbara Marcin

Portfolio Manager, Gabelli Asset Management, Inc.

"We think dividend-paying stocks are in the 'sweet spot,' and investors should make these the core of their portfolio," says Barbara Marcin, manager of the Gabelli Blue Chip Value fund. Here, she provides her market overview and a selection of her favorite dividend payers.

"Certainly, over the longer term, there are opportunities outside the US, and it makes sense for investors to participate in faster-growing economies with perhaps 10% to 15% of their investment funds. However, for the next year or two I think the growth profile in the US is very good, and there are many sectors and stocks selling at low multiples and offering good dividend yields. So I would say that for now you don’t have to look elsewhere for good returns. You can find good value right here at home.

"We are in a moderate-growth economy, and still, low interest rates are giving impetus to the market. We also have capital spending picking up; and confidence has picked up a lot. In addition, Congress enact a corporate tax law in October that allows corporation repatriate earnings that they have ‘parked’ overseas. This could result in $100 billion coming back to the US. So there is still impetus to spending that we see ahead. This bodes well for the stock market. The next few years should be marked by ‘back to basics’ strategy, with the best opportunities in stocks with reasonable p/e multiples and very good cash. Dividends will be the sweet spot in the market, along with good dividend-paying stocks that will outperform over the next few years.

"Meanwhile, I'd point out that there are a couple of things that are currently out-of-whack on dividend-paying stocks. The dividend yield on the stock market – if you go by the S&P 500 – is about 1.7%. That is way out of line with the long-term dividend yield on the stock market, which has been about 4%. That payout declined dramatically in the 1990s. The other thing that is out-of-whack is the amount of money that corporations pay out of their earnings in the form of dividends. Right now they pay out about 33% of earnings, while the long-term average is 50% of earnings being returned into the pockets of shareholders.

"In the 1990s, companies found every reason under the sun not to return money to shareholders. Indeed, their stock prices tended to rise when they announced that they had something more interesting to do with their money than pay dividends; and that is why the dividend return has fallen so much. However, there is every reason to think that over the next three, four, and five years or longer that dividend payout ratios will rise and the yield on stocks will rise a lot. Any that will help drive returns on stocks. That’s why we think dividend-paying stocks are the ‘sweet spot,’ and we think investors should hold these stocks as a core portion of their portfolio.

"Despite the historically low dividends of the general market, you can find good dividend-paying stocks in such areas as financial companies, pharmaceuticals, telecom, etc., all of which yield 3% to 4% with p/e multiples of 11-12. For a diversified package of a dozen stocks, I would suggest Kerr McGee (KMG NYSE), Chevron Texaco (CVX NYSE), Verizon (VZ NYSE), SBC Communications (SBC NYSE), Bank of America (BAC NYSE), Citigroup (C NYSE), Merck (MRK NYSE), Wyeth (WYE NYSE), Ameren (AEE NYSE), Hawaiian Electric (HE NYSE), ConAgra (CAG NYSE), and Du Pont (DD NYSE), for a nice list of issues that offer income and appreciation.

"Finally, I’d add that in my mutual fund, the Gabelli Blue Chip Value Fund, I also look for returns by trying to invest in undervalued, unloved, and out-of-favor stocks, such as AES (AES NYSE), Sovereign Bank (SOV NYSE), and Microsoft (MSFT NASDAQ). In these cases, I am looking for stock appreciation as a result of higher multiples put on higher earnings as the luster is restored to these companies. I’d also note that pharmaceuticals have been out-of-favor in recent years; no sector has been hit harder. The reasons are that the growth profile has fallen, patents have been expiring, and of course, more recently, there have been problems such as Celebrex and Vioxx, as well as concerns about pricing limits. This group is definitely out-of-favor. But the longer-term earnings growth prospects for these companies are very good. Along with Merck and Wyeth in our list above, I would note that Sanofi-Aventis (SNY NYSE) and Pfizer (PFE NYSE) are good ideas if you have a one- to three-year time frame."

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