During the tech mania John Snyder seemed stodgy. But in the age of modest gains and big disappointments, he's looking downright hip.
Snyder has managed the (SOVIX)John Hancock Sovereign Investors fund for more than 18 years, focusing most of his attention and his funds' money on "dividend performers," or stocks of companies that have raised their dividends for at least 10 consecutive years. There are more than 300 of them out there, primarily titans like Citigroup (C), IBM (IBM) and ExxonMobil (XOM). To peruse the full list, check out the latest edition of Mergent's Dividend Achievers.
While focusing on those biggies doesn't necessarily lead to pulse-racing results, investors who chased growth in recent years might want to note that bankrupt energy trader Enron wasn't a dividend performer. And his fund has topped the S&P 500 in each of the past two years. In fact, the fund's 6% dip last year was just the fund's second down year on his watch -- it fell 2% in 1994.
Today Snyder thinks stocks are fairly valued, and he's picking up shares of Fannie Mae (FNM)
and select capital goods stocks. He doesn't think the U.S. consumer can do much more to boost the economy and doesn't expect eye-popping stock gains. Where is Snyder investing, and why is it important to consider dividends in a market with modest prospects? Read on.
1. What's the case for dividend performers today?
We're in a back to basics market. I think that quality and valuation play a greater role than they did a couple of years ago. I think that earnings stability plays a greater role, too. Dividend performers are companies with strong balance sheets that have endured different cycles, have strong cash flow and are the 800-pound gorilla within their industry.
What we're finding is that the strong get stronger in this [economic] downturn. Most dividend performers tend to be higher quality, stronger companies, and right now the valuations really aren't that different for stronger companies or low-quality companies.
2. What do you look for in a company, beyond a solid dividend record, before you buy shares?
|Fund: (SOVIX)John Hancock Sovereign Investors
|Managed Since: Jan. 1, 1984*
|Assets: $1.7 billion
|One-Year Return: -3.4%/Beats 49% of Peers
|Five-Year Return: 7.6%/Trails 53% of Peers
|Expense Ratio: 1.08% vs. 1.42% category avg.
|Maximum Sales Charge: 5% on Class A shares
|Sources: Morningstar and jhancock.com.
Returns through March 5. *Co-managed with Barry Evans since August 1996.
Fundamentals and valuation have to come first. Is the company continuing to generate higher revenues and keep profitability where we expect it to be? Do we see anything that might make that change? When we look at valuation we ask, what [earnings] growth rate does the market anticipate today? Do we think that's higher or lower than the company's actual growth rate? That's what we ask.
We find opportunities in misperception, and [mortgage giant] Fannie Mae is an example. They're getting lambasted by The Wall Street Journal
every day -- it seems like every day anyway. Well, we feel that the points that the Journal
is making are incorrect. But this creates a dislocation between fundamentals and valuation. We look for situations like that where we buy the stock or add to holdings.
3. Enron wasn't a dividend performer, but it was a well-regarded company. In the wake of its collapse, do you find yourself asking different questions?
We've always focused on the quality of earnings. Also, to be perfectly frank, things come up, and they're surprises. You just don't see them coming. If you think about the pond we fish in, it's made up of companies that have done whatever they do for a very long period of time. That doesn't make us immune to these problems, but that approach lowers the odds of something like an Enron being in our portfolio.
We actually looked at Enron a couple of years ago. The stock was doing pretty well. I asked an analyst to look into it, and he came back and told me he just didn't understand the company. That was good enough for me. We never owned it.
4. Given your approach, what sectors and companies do you like today?
Snyder's dividend-rich approach hasn't been too volatile
|Sources: Morningstar. Returns through March 5.
Recently, we've gotten into some capital goods stocks. The downturn we had gave us a recession in capital spending, technology and capital goods. So valuations got to a reasonable level. We were looking for companies that were being hurt by the economy, but that were executing well internally. So, we bought Air Products & Chemicals (APD)
, which is an industrial gas company. Their products go into electronics and health care and other areas. We've followed the company for a long time. What we've never liked is that they spent tons of money every year, without a rational return on invested capital.
But now the company has started to focus more on their return on invested capital. We feel it's a reasonably priced stock, and if the economy picks up, they'll benefit from all the rationing and cost-cutting they've done.
Another company we like in that area is Honeywell (HON)
. They've been through a difficult two years with the on-again, off-again merger with GE (GE)
. During that time, it was a poorly managed company. But now [new Chief Executive Larry] Bossidy has come in. He used to run Allied Signal
, which merged with Honeywell. He has done a lot of good things like rationalizing the business operations and closing a lot of plants. You've got a reasonably valued company here.
We've also been adding to several financials, like Fannie Mae. There's lots of talk about their derivative exposure, but they've been doing that for more than 10 years. They obviously have great market share, great management and predictable earnings. It's a stock trading at around 11 times estimated earnings in a market that trades at about 23 times estimated earnings. The stock has historically traded at about a 20% discount to the market.
I like the company, I like the business, and I think they provide mortgages cheaply and more efficiently than anyone else can. We think it's an excellent buy here.
5. As you say, the S&P 500's forward P/E multiple is about 23, compared with 15 on a historical basis. Do you look at stocks as being cheap or expensive overall today?
I think the market is fairly valued. I don't think it's cheap. At the same time, I don't think it's expensive either. With inflation at about 2% and long-term bonds yielding about 5%, I don't think you can make the case that the market is overvalued. But do I think we'll get multiple expansion from here? Probably not. I think you get appreciation from here, from earnings growth and dividend growth.
The old formula that if you want to know what you'll earn from a stock, just add its earnings growth and dividend?
That's what I
6. Whether they pay dividends or not, most companies are affected by the economy. What's your outlook there?
In the first half of this year, it will appear that the economy is very strong. But simply replenishing inventories will drive a lot of that. The question is, how strong will the economy be compared to times where we came out of downturns in the past? I think it will be significantly less strong. This has been an unusual downturn because, for the consumer, there hasn't been a recession. Mostly due to declining interest rates, people have been able to refinance mortgages and buy cars with 0% financing. The question now is, how many cars do you need in the garage?
If the consumer is 75% of our gross domestic product, I just don't see how the consumer can be the driving force here. That's been the case in other downturns. That's why we'll have a subpar economic recovery in 2003 and 2004.
7. There aren't a slew of dividend performers in the tech sector, but it's still widely owned and followed. What's your take there?
I believe that tech is an area where you trade, and that's a different view from my colleagues. I don't think you can make long-term investments in tech right now because the stocks have come down a lot, but so have the earnings. These are growth cyclicals, so what kind of multiple do they deserve? In 1998, 1999 and the first part of 2000, these were perceived as high-quality, long-term growth stocks. That was in a time when we thought interest rates and the economy couldn't hurt them.
Turns out that wasn't the correct assessment, but what do you pay for them? Valuations have not contracted to where they were earlier in the 1990s. The earnings need to grow into the valuations in this area. It could be a couple of years before these companies become good long-term investments with more reasonable valuations.
8. What's your fund's usual bond stake, and what is it today?
It's usually between 8% and 12%. We're right in the middle of that at this point. It's been moving down a bit lately. The bonds we have in there are corporate bonds
and high-yield bonds
. I like that area right now, high-yield bonds. If you're in the telecommunications area, you have a problem, but the other areas in the high-yield market are OK. It may actually be a good total-return vehicle this year.
Do you think bonds have a chance to beat stocks for the third year in a row?
I don't think so. I think the equity market will do better. I don't think the returns will be great, but they will be better than the fixed-income market.
9. There's still a lot of risk in the market, with a lot of companies that are household names and seem safe but are still due to crumble. What sector or stocks are you avoiding?
One area where I've reduced positions is retail. Our most recent removal there was Home Depot (HD)
. Obviously, a big brand name and a good company, but because of solid consumer spending over the past couple of years, I'm not sure that Home Depot's business will pick up a lot. The valuation also has gotten to be a bit stretched. I see their earnings growing more now as a function of cost-cutting, which is fine. But I don't see the revenue growth going forward that we've seen in the past. I think you pay a lower multiple for cost-cutting efforts rather than strong top-line growth.
10. Everyone is looking for companies where they can have confidence in management, see earnings predictability and not pay a high price. What are some companies that fit this profile and are worth holding for five years?
One is Fannie Mae. I would buy that stock and not worry about it. Another is American Home Products (AHP)
. There are issues in the pharmaceutical area, primarily patent expirations. But that's not impacting them as badly as their competitors. Three or four years ago, they weren't well-regarded, but they've done a good job restructuring their business and coming up with some drugs that are quietly adding value. I think it's a company that can grow at about 12% a year for at least three years. You've got about a 2% yield, too. So in the worst-case scenario, the stock holds its current valuation and you get a return that matches the earnings growth and the yield.
Another I'd pick for people interested in a higher yield is Duke Energy (DUK)
, which pays about a 3% yield. Duke has gotten crucified because of the Enron situation. They're very well-managed and are probably the blue-chip of the energy area with lots of diversification. The stock and valuation are both way down. One of my analysts was in New York talking to them [recently]. We think they can grow earnings at around 11% or 12% a year. You get good growth with a cheap valuation. That's good for a conservative investor.