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May 2004
Often in the economy, as in the kitchen, you can have all
the right ingredients, but still not necessarily bake the
perfect cake. Dividend paying stocks are a sound and smart
way to invest in the stock market. In my commentary of December
2002, I summarized the factors driving positive momentum in
the market and the benefits of the new tax package that, in
my opinion, should have propelled dividend paying stocks to
higher levels. Dividend paying stocks did well last year.
For example, the Dow Jones Industrial Average stocks, which
all pay dividends, returned 28.20% in 2003. I continue to
believe, however, that dividend paying stocks will do even
better in 2004, and I forecast that the Dow Jones will reach
11,000 by year end.
Many investors view dividends as a sign that a company is
doing well and doing right by its shareholders. If a company
has enough cash in the coffers, the company enriches their
investors by paying a dividend. And, dividend investing tends
to have less volatility than the overall market. In 2002,
for example, when the S&P 500 fell 22% overall, stocks
in the index that paid a dividend fell only 11%, while non-dividend-paying
stocks fell 30%*. When an investor is interested in risk-adjusted
investments, dividend investing deserves deeper consideration.
With the recent tax cut on dividends, more and more companies
are paying a dividend or increasing their current dividend.
A great example of this is Microsoft, who paid its first ever
dividend in March, 2003, and in November, doubled it. Other
companies, such as Citigroup and Wells Fargo, increased their
dividend last year by better than 50%. And, with tax season
recently passed, many investors are now finally beginning
to realize that dividend income is now taxed at 15%, like
a capital gain, instead of as ordinary income, with rates
as high as 38%. Currently there are many companies sitting
on large amounts of cash, not sure where to invest it. To
pass on this value to their shareholders (and, remember, in
many cases, top management of a company can be some of its
largest shareholders), I believe these companies will consider
paying out or increasing their dividend. Additionally, an
increase in a dividend or the adoption of a dividend has historically
improved the underlying price of some stocks.
At Hennessy Funds, we are obviously bullish on dividend investing.
We offer investors the opportunity to buy dividend paying
stocks in a mutual fund format. We manage three funds, all
of which invest in large, high-quality, high dividend yielding
stocks. The major difference between the funds is the percentage
of the portfolio in stocks and the portfolio’s risk,
or volatility. Dividend yield is calculated as the annual
dividends paid by a company divided by the price of a share
of their stock. In addition to dividends providing a stream
of income, we also believe that a high dividend yield is a
strong indication that a large-cap stock is undervalued and
prime for price growth.
The Hennessy Cornerstone Value Fund invests its assets entirely
in stocks. The Cornerstone Value formula screens for companies
that are very large, are widely held and have above average
sales and cash flow. From this list of “Market Leaders”
the fund buys the 50 highest dividend-yielding stocks. The
fund invests in companies whose name you may not be familiar
with, but brands you most likely are. For example, Cornerstone
Value invests in Diageo PLC, with leading brands like Smirnoff,
Johnnie Walker, Jose Cuervo, Captain Morgan and Guinness.
It invests in Sara Lee Corp., who distributes the well-knows
brands of Jimmy Dean, Hanes, L'eggs hosiery and Champion active
wear. And it holds Conagra Foods Inc., which manages trusted
brand names such as Hunt's, Healthy Choice, Butterball, Banquet,
Reddi-wip, Slim Jim and Orville Redenbacher.
Because it is 100% invested in equities Cornerstone Value
is the most aggressive of our dividend-focused funds. However,
as I mentioned above, investing in dividend-paying companies
has historically been less risky, or volatile, than investing
in the market overall. A common measurement of volatility
is “beta”, which tracks a portfolio’s sensitivity
to market movements, as represented by the S&P 500 index.
The S&P 500 index has a beta of 1.0, so anything less
than 1.0 indicates that a fund’s historical returns
have fluctuated less than the S&P 500. The Cornerstone
Value Fund has a beta of 0.92
The Hennessy Total Return Fund invests 75% of its assets
in the 10 highest dividend-yielding Dow Jones Industrial Average
companies. The 30 Dow companies are some of the largest and
well-recognized companies in America, such as General Motors,
Exxon Mobil, and GE. These ten highest dividend-yielding Dow
stocks are commonly referred to as the “Dogs of the
Dow”. The remaining 25% of assets are invested in one-year
U.S. Treasury securities. This fund seeks to exceed the total
return of the Dow Jones Industrial Average in the long run,
but do so with less volatility. With a smaller percentage
of assets in equities, this fund has less risk and volatility
than the Cornerstone Value Fund. The beta of the Total Return
Fund is 0.82.
Our most conservative fund, the Hennessy Balanced Fund invests
50% of assets in the 10 highest dividend-yielding Dow Jones
stocks, or “Dogs of the Dow”, but limits exposure
to market risk and volatility by investing 50% of assets in
one-year U.S. Treasury securities. This fund, with a beta
of 0.51, has only half the risk and volatility of the overall
market.
Over the past year and a half, many factors are pointing to
a continued and sustainable market recovery. The interest
rate environment remains low, inflation is low, job creation
is increasing, corporations are seeing higher earnings and
we captured Saddam Hussein. These developments, in my opinion,
should have produced significantly higher investor confidence
and pushed the markets to new levels. However, investors still
seem hesitant and continue to wait on the sidelines. Perhaps
they are frustrated that all of these positive economic indicators
have not pushed the economy forward fast enough. Maybe they
lost money during 2000-2002 and fear that the great returns
from 2003 are not sustainable. My fear is that investors who
are waiting will miss the next leg of the bull market.
While dividends may not be quite as exciting as the hot stock
tip you hear about at the water cooler, investors would be
better served by holding risk-adjusted investments with proven
results than by following hot investment fads, or waiting
on the sidelines. With the market poised for continued positive
momentum, and with the reduced tax rate on dividends, there’s
never been a better time to consider dividend investing. In
my opinion, investors who buy high quality stocks, including
those that pay dividends, and who have the discipline to stick
with them will be rewarded over time.
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