Top stock picks from top pros
They racked up some of the best fund returns of the Lost Decade by sticking with this simple strategy: Buy quality. Here's where they see opportunity now.
Their picks: Verizon, AT&T and IBM
"There's another step to the wireless story," says Davis. who has been the fund manager with Dahlberg for seven years. "There's more data use ahead. And Verizon and AT&T have the two best networks in the U.S. Both are yielding around 6%, so we don't need a lot of capital appreciation on top of that."
"IBM went from being a manufacturing company to one based on services and software, which is much less capital-intensive," Dahlberg says. "The company compounded its dividend by more than 25% a year and is paying out only 22% of its cash flow. So there's opportunity for the dividend to grow dramatically."
Their strategy: Rather than chasing the stocks with the highest yields, Dahlberg and Davis seek businesses that can afford to raise their dividend. To determine if a company can do this, the managers look at "free cash-flow yield" -- the money generated per share after expenses and capital investments, divided by the stock price.
Today the stock market has a free cash-flow yield of 5.5%; the fund's average is 7.2%. Says Davis, 54: "We're the Jerry Maguires of investing: Show us the cash."
Thanks to their strategy, Dividend Income's yield has been reliable, and growing. In 2009, when a record number of S&P 500 firms cut their dividends and only 42% raised their yield, more than half of the stocks in the fund's portfolio increased their payout.
Where they see opportunity: "We're in a slow-growth environment," says Davis, "but there are still companies with solid balance sheets trading at a discount from a decade ago that have continued to increase their dividends.
"Today we have a heavy commitment to telephone companies. Their dividends account for two-thirds or less of their free cash flow. So there's room to grow the yields at least in line with inflation."
Like Davidson, they see tech stocks as another emerging area for income. "Ten years ago tech companies were lousy stewards of their capital," says Dahlberg, 71. "They invested excessively at the top of the business cycle and had trouble during downturns. But they've become better stewards, and more of them are sharing cash with investors."
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