Dividend and Conquer

By JON D. MARKMAN

Dec. 3, 1996 12 AM PT

There’s nothing quite like bad news to make Nancy Tengler and Geraldine Weiss take notice. A chemical plant explosion in India, an oil slick in Alaska, even a mass murder in a cafeteria in Texas. They deplore the loss of life, of course. But they also know the temporary effect that grim headlines can have on great stocks.

When everyone else is selling shares in a panic, their dividend-based disciplines keep them cool and steady, laying traps for plunging stocks and snaring them as bargains.

Tengler and Weiss, two California money managers, track the rise and fall of stocks’ dividend yields to determine whether securities are overvalued or undervalued. Their strategies are worth a close look as the market continues to soar, making many investors wonder if any companies’ shares are still truly cheap.

Indeed, in this bull market, dividends have almost been forgotten. They get little respect as investors focus on capital appreciation. Never mind that studies repeatedly indicate that dividends account, over time, for half the stock market’s total return.

Tengler and Weiss have plenty of respect for dividends. In their strategies, they examine the stocks of the nation’s largest, most mature companies that have increased dividends for years. They start with a conviction that past earnings, and securities analysts’ estimates of future earnings, don’t predict price moves of these stocks well. Instead, they focus on whether a company is distributing more or less of its profit in the form of cash dividends.

They’re seeking the statistical rhythm of a stock as it swings between the poles of greed and fear, believing that high-quality growth stocks inevitably fall out of favor on Wall Street because of some catastrophe or another, then float back up on the wings of angels over two to four years as the bad news is forgotten or management reorganizes.

That’s about where the two part company. Tengler, in San Francisco, compares a stock’s current dividend yield to the average for the overall market mainly to gain information about whether a stock is cheap relative to its peers. Weiss, in San Diego, mainly compares a stock’s current yield with its own historical yield and is a bit more focused on dividend income.

The importance of dividends, Tengler and Weiss say, is that they are profits that a company shares with its owners. Dividends aren’t theoretical, like some numbers on a balance sheet. When a company increases its dividend, it makes a powerful statement that it expects to sustain or boost its earning power. “A company that pays a dividend has to earn it,” notes Weiss. “Once it’s paid, it’s gone forever.”

A stock’s yield is its annual dividend per share divided by its price per share, expressed as a percentage. The yield therefore rises when a stock’s price falls, assuming no change in the dividend; likewise, the yield falls when a stock’s price rises.

A stock that pays a healthy dividend when its price is low usually has a high yield. That can be a good sign, if it means the company is telling you it expects good times ahead even if the stock is currently in Wall Street’s doghouse. However, a high yield can also mean that things really are bad and that the board of directors simply hasn’t gotten around to lowering the dividend. (An example, provided in the new book “The Dividend Rich Investor” by Joseph Tigue and Joseph Lisanti of Standard and Poor’s Corp.: IBM stock’s yield was 10% in 1993 at a time when the average blue chip stock’s yield was 2.9%. Less than a month and a half later, IBM announced a 55% cut in the dividend.)

Another statistic that helps in using a dividend strategy is a stock’s payout ratio, which measures the percentage of earnings paid out in the dividend. In general, the lower the number--say, around 50% or below--the safer the dividend. Companies with very high payout ratios are being generous in sharing profits with investors, but they may also may be near the peak of their ability to increase dividends and thus in danger of cutting them back.

A low payout ratio can give investors more comfort when a stock is volatile and the yield is high. For example, shares of tobacco and food giant Philip Morris yielded a lofty 5.17% on Nov. 1, when the stock plunged to $92.88 amid more harsh words about cigarette regulation from Washington. But Morris’ payout ratio is just 54%. By the time hard-driving Food and Drug Administration chief David Kessler announced his resignation Nov. 25, Morris stock had shot up 13% to $104.75 and as a result sported a more moderate 4.5% yield, closer to its five-year average.

Tengler, who manages three mutual funds and has private and institutional clients for Union Bank of Switzerland, deploys a strategy called relative dividend yield to spot winning stocks like Philip Morris (for a prospectus of her UBS U.S. Equity Fund, call [800] 914-8566).

Using the Standard & Poor’s Compustat database of stock data stretching back to 1962, she and her UBS team have plotted the yield histories of about 100 large U.S. stocks on charts that also show the yield history of the S&P; 500 stock index. You can find 95 of the charts in the appendix of a book she co-wrote with colleague Anthony E. Spare called “Relative Dividend Yield: Common Stock Investing for Income and Appreciation” (John Wiley & Sons, 1992, $39.95).

Tengler says the charts show that when a growth stock like Coca-Cola stumbles, as it did in the early 1980s, its yield rises to a perch more than 25% above the S&P; 500 yield. That’s a signal, she says, that such a stock is undervalued.

When Coca-Cola’s price hit bottom, its yield peaked at 60% higher than the S&P; 500 yield. The stock, now fully recovered and probably overvalued, today has a yield of less than half that of the S&P; 500.

Tengler said her team begins to buy little by little as a stock’s relative yield increases, and that they only sell when the relative yield evens up with the market. They expect to double or triple their money in a stock over two to four years with this strategy.

To determine a stock’s relative yield, divide its current yield by the S&P; 500 yield, which is found in the Stock Market Barometers chart on D5. The S&P; 500’s yield is 1.97%. To figure Philip Morris’ relative yield, for instance, divide its current 4.65% yield by 1.97%. That equals a relative yield of 2.36, which can also be expressed (rounded) as 240%. The stock’s yield is therefore 2.4 times the yield of the S&P; 500--a screaming buy, Tengler says.

Of course, this strategy, as with any other, has its detractors. For one, dividends aren’t the only way to reward investors, and historical data may mislead. David Fried, editor of the Buyback Letter ([888] 289-2225) observes that many companies today are using profits to repurchase shares instead of raising their dividends. In 1984, he notes, Coca-Cola paid out 60% of its profits in dividends. Coke then purposely cut its payout ratio to 40% and now has set a goal of 30%. It plans to use the difference to expand operations and buy back stock.

To determine a company’s true shareholder yield, Fried adds the amount spent on buybacks to the amount spent on dividends. In 1995, the average price of Coca-Cola was about $35 and the company paid 44 cents a share in dividends. Fried says Coca-Cola spent an additional 35 to 40 cents a share repurchasing stock, giving it a true yield of 2.6%--much closer to the S&P; 500 yield than the dividend yield alone would indicate.

In addition, he notes, a dividend strategy ignores high-growth companies like Microsoft that don’t pay a dime in dividends and instead reinvest all of their profits in their businesses.

Historically, however, Tengler’s technique has performed quite well, about 2 percentage points better than the overall stock market return, and with low risk and very little buying and selling of stocks--a big plus for rich clients whose greater gains from strategies with higher turnovers get eaten by taxes.

This year, however, the market’s high-growth orientation has stress-tested the strategy. Tengler’s mutual fund, which typically holds 50 stocks, is up 15.4% through Nov. 27, about 9 percentage points behind the S&P; 500’s return.

Unlike Tengler, Weiss insists that dividend yields show that stocks are vastly overvalued by historical standards, and she warns investors that they should have only 30% of their assets in the market.

In a twice-monthly newsletter called Investment Quality Trends ([619] 459-3818, $275 a year), Weiss ranks the stocks of 350 high-quality companies according to the ratio of their own current and historical yields. Weiss recommends buying stocks at the high end of their historical yield curves and that have payout ratios less than 85% and debt equal to less than 50% of capital.

Many of those stocks today are high-yielding utilities, but retail giant Limited also fits.

The company is rated a rock-solid A+ by Standard and Poor’s and has a debt load of less than 20%, and its share price recently fell to $18 with a dividend of 40 cents. Its latest annual earnings were $1.40 per share, giving the company a very low payout ratio of 29%.

“That’s telling you they have lots of room to raise their dividend, which automatically lifts the stock,” Weiss says.

Now for the math: Limited’s current yield is 2.2% (40 cents divided by $18, times 100 to get the percent). To determine the price at which the stock would be overvalued, Weiss says, divide the current dividend by the lowest historical yield. Using a proprietary algorithm, she pegs that low yield for Limited at 0.4%. That makes her target on the stock $100 in three years--or a fivefold increase from today. Of course, if a major market decline occurs, all bets are off.

A similar stock, she says, is Luby’s Cafeterias, rated A by S&P.; At $22 a share now, the stock’s dividend yield is 3.6%. Weiss forecasts a 180% upside for the stock.

Weiss says her list of undervalued and rising stocks has slightly outperformed the S&P; 500 this year; her 10-year record is among the best tracked by Hulbert Financial Digest, a newsletter that tracks other newsletters’ performance.

Her current advice: “Anyone who sticks to good quality and good value doesn’t have to do anything exotic to consistently beat the market averages. It’s all about consistency--investing not for today or tomorrow, but at least three years down the road.”

Street Strategies explores tactics that the nation’s savviest private and institutional investors use to maximize gains and minimize risk. Jon D. Markman is a Times staff writer. He can be reached at jon.markman@latimes.com

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Hunting for Higher-Dividend Stocks

Nancy Tengler’s Choices .

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Mon. Div Company Ticker close yld P/E* RDY* General Mills GIS $64.38 3.1% 25 160% Bristol-Myers Squibb BMY 115.75 2.6 26 140 Weyerhaeuser WY 47.13 3.5 15 170 J.C. Penney JCP 54.13 3.9 16 200 Philip Morris MO 103.25 4.6 14 240

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Comments

General Mills

Nation’s No. 2 domestic cold cereal producer, it took 3% market share from Kellogg recently; strong innovator; RDY at 30-year high; increasing dividends 6% a year; buying back 2% of stock a year; with 12% earnings per share growth expected, implied total return is 15.5%. Expect double in 3 years.

Bristol-Myers Squibb

Cheapest drug company on relative-yield and P/E basis; has three drugs with blockbuster sales potential (anti-cholesterol, anti-cancer, anti-diabetic); Clairol unit reviving amid aging of baby boomers; recently linked executive compensation to stock price.

Weyerhaeuser

Largest private owner of premium softwood lumber in the world, 20 million acres; CEO focused on generating superior stock returns; insider ownership 12%; highest RDY ever; has never cut dividend; annual compound growth rate 28%; highest-rated forest-products company.Largest private owner of premium softwood lumber in the world, 20 million acres; CEO focused on generating superior stock returns; insider ownership 12%; highest RDY ever; has never cut dividend; annual compound growth rate 28%; highest-rated forest-products company.

J.C. Penney

Most attractive retailer on RDY basis; nation’s largest retailer of Nike products and diamonds; largest operator of beauty salons; as cheap as it’s ever been; other times this low have been followed by double and triple stock price performance over 2-3 years.

Philip Morris

Price depressed by litigation risk and anti-tobacco campaigns, but only 17% of revenues come from domestic tobacco sales; foreign growth explosive; relative yield at all-time high; dividend raised 20% three times; stock up 100% since Marlboro price cut of April 1992; expect at least a double in 3 years.

Geraldine Weiss’ Choices .

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Mon. Div Percent Percent Company Ticker close yld P/E* upside downside AMP AMP $38.63 2.6% 17 126% 15% Dun & Bradstreet DNB 22.63 3.9 NA 127 25 Bob Evans Farms BOBE 13.00 2.5 23 123 0 Ennis Business Forms EBF 9.63 6.1 10 209 0 Ethyl EY 9.00 5.6 12 250 11 The Limited LTD 18.25 2.2 14 456 10 Luby’s Cafeteria LUB 21.75 3.6 13 182 0 Enova ENA 22.25 7.0 11 78 10 Consolidated Edison ED 28.75 7.2 10 103 18 Delmarva Power DEW 49.75 7.7 11 205 19

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Comments

AMP

Electronics equipment firm offers high-tech exposure; very low debt.

Dun & Bradstreet

Price depressed mostly because of restructuring; no debt.

Bob Evans Farms

Price irrationally depressed by infighting among family insiders; no debt

Ethyl

Chemical manufacturer

The Limited

Women’s apparel chain very cheap on historical basis; generous, regular dividend increases.