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Get Four
|  | DECEMBER 28, 2004
The Decade of the Dividend? Stephen Goddard of the New Market Fund sees cash distributions playing a bigger role in investing -- and he runs his fund accordingly Stephen M. Goddard, founder of investment firm London Co. and manager of its New Market Fund (AVMIX ), expects "very modest returns" from stocks generally in a market with relatively high valuations. But he's not so worried because he expects dividend payouts to "increase substantially over the next several years." Indeed, that likelihood has Goddard comparing the next decade to "a period like the '30s and '40s, and even the early '50s," he says, "when investors purchased stocks simply for the dividend, not for speculation." He also notes that most mutual-fund managers are "closet indexers," investing in 100 or so stocks, when 95% of diversification can be achieved with 20 or fewer securities. As a result, the New Market Fund is much more concentrated than most equity funds, yet it's among the lowest-risk funds listed by Morningstar and handily outperforms the Standard & Poor's 500-stock index. Goddard says the fund looks for companies with rich cash flow and the ability to maintain dividends. Its top three holdings are all in financial services: Berkshire Hathaway (BRKB ), White Mountains (WTM ), and Markel (MKL ). He also likes health-care names Johnson & Johnson (JNJ ) and Novartis (NVS ), and consumer stocks such as Anheuser-Busch (BUD ), Kraft (KFT ), and Gillette (G ). These were a few of the points Goddard made during an investing chat presented Dec. 23 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at keyword: BW Talk. Q: Steve, do you think this Santa Claus rally has legs to take it beyond the holidays? A: It's a little ahead of itself, relative to where the recent valuation levels should currently be. Usually, the market trades at about 100% to 110% of gross domestic product, and now we're at about 140% of GDP. So either the market needs to drop substantially or the GDP has to catch up to market valuation. Therefore, we expect very modest returns over the next decade. We expect that dividends will be a much more integral part of your returns going forward. And we expect dividend payouts will increase substantially over the next several years. Q: With your cautious view of the market ahead, what should investors do? What's your fund doing? A: We're positioning the fund to look for companies that have the ability to pay substantially higher dividends going forward. Therefore, we look at companies that generate a lot of free cash flow, have relatively minor capital needs, or have substantial amounts of cash on hand. For instance, our largest holding, Berkshire Hathaway, is sitting on almost $38 billion in cash, and they probably have an additional $30 billion in short-term securities. They could do something similar to Microsoft (MSFT ), and if they wanted to, they could pay $38 billion out as a special dividend. They also could have a much higher dividend going forward on an ongoing basis. Tyco (TYC ) is another example of a company that has a large amount of free cash flow, yet their payouts are very low. You're starting to see larger companies increase their dividends by 15% to 25%. We will likely see other companies follow suit. We really believe that the market is going back to a period like the '30s and '40s, and even the early '50s, when investors purchased stocks simply for the dividend, not for speculation. It used to be, up until the late '50s, that the overall yield on the stock market was higher than that on bonds. It's only in the last 20 or 30 years that dividends have become a very small component of your return because of the above-average appreciation in the marketplace of 18% per year. As we go into the new decade, we'll probably have the other extreme -- below-average appreciation and substantially higher-growing dividends. Q: Can you sum up your strategy for the New Market Fund and for your investment firm, London Co.? A: Our strategy for the fund and the firm are the same. We're simply looking for high-quality, predictable, free-cash-flow companies that have the ability to pay growing dividends over the next decade. More importantly, we believe that we don't overdiversify, so that we give the fund the ability to outperform the overall stock market. Some 95% of the industry tends to be closet indexers, buying 100-plus securities with no meaningful position in any one particular. That's the reason why most active money managers underperform passive indexes. Q: And has the fund outperformed the overall market? A: Oh, yes. Over three years, five years, since its inception. Year-to-date, we have outperformed the market significantly. Q: If you don't overdiversify, how many stocks does the fund hold? A: Currently, we hold 40 securities, which is more than we normally hold, but because of the recent fund that we acquired, for tax reasons we had to hold more securities than we normally do. Our top 10 positions are normally over half of the portfolio. In some cases, we have had individual positions which were well over 10% of the portfolio. You have to take a meaningful position somewhere in order to outperform over time. Q: Besides BRK and TYC, what are some of your top holdings? Are they mostly large-caps? A: Our average market cap is well over $20 billion. We do have small-cap and mid-cap names in our portfolio, but less than 25%. Besides Berkshire, our largest positions are White Mountains, Markel, Kraft, and Gillette. All of these companies are very well managed, grow cash at above-average rates, and have the ability to pay growing dividend payouts. Q: Are there areas where you are most likely to find the kinds of stocks you like? I would guess tech doesn't have many of them. A: Normally, financial services, consumer, and health care. Technology normally isn't predictable enough for our comfort level. We like to stick with companies we know are going to be around 10 years from now.
BW MALL
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