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All dividends, all the time
The MP 63 Fund focused on dividends long before dividends were cool, an emphasis that's paid off even in a bear market.
By Timothy Middleton
Earlier this month, shareholders of Illinois Tool Works (ITW, news, msgs) were paid a quarterly dividend of 23 cents, which works out to 92 cents annually. That amounts to a yield of about 1.5% for the owners of the big machinery maker -- more than Treasury bills and with the upside potential of equities.
Around 1,000 American companies pay dividends. Like Illinois Tool Works, they tend to be concentrated in traditional businesses like banking, manufacturing and pharmaceuticals. Companies like these, and their shareholders, stand to gain if President Bush succeeds in eliminating the taxes individuals pay on corporate dividends.
But even without a tax break, dividends matter. During the bear market, dividend-paying companies resisted the markets decline to one degree or another. A mutual fund that invests in nothing but dividend-paying stocks, The MP 63 Fund (DRIPX), ranks among the top 5% of funds investing in Fortune 500-type companies, according to Morningstar.
The fund tracks the 63 stocks that constitute an index of dividend-paying stocks created in 1994 by The Moneypaper, an investment newsletter that advocates participating in dividend reinvestment plans, or DRIPs. Since then, the benchmark has risen about 145%, compared with a gain of about 129% for the Dow Jones Industrial Average ($INDU).
Still young
Just under 4 years old, with assets of less than $20 million, MP 63 Fund was created to allow shareholders to participate in its favorite companies in accounts such as IRAs that dont meet the requirements of DRIPs.
It also provides a fairly well-diversified portfolio of solid, long-lived companies. Investors who've been disappointed with the risks taken by bolder stock funds might find this one more to their taste.
Dividend reinvestment plans were created to encourage shareholders to put their money back into the business rather than spending it somewhere else. Reinvesting dividends is virtually taken for granted with mutual funds, but its uncommon in the world of common stocks.
The reasons range from the prosaic to the philosophical. As a practical matter, funds are commonly sold in dollar amounts rather than full shares, whereas with stocks its the reverse. Selling shares directly to investors, rather than through Wall Street firms, also defies tradition.
And philosophically, most companies shun dividends altogether, because the so-called double taxation Bush wants to eliminate discourages them. Dividends aren't tax-deductible, as interest payments are, so Corporate America overwhelmingly prefers issuing debt to equity.
Big advantages
But some companies that do pay dividends also encourage shareholders to participate in DRIPs. In addition to allowing the reinvestment of dividends, many plans also allow shareholders to buy additional shares in round-dollar amounts and without paying commissions. Some even offer their stock at a discount to DRIP enrollees.
Enough corporations offer DRIPs that the MP 63 index is broadly, though incompletely, diversified. The top 10 holdings cover a host of sectors.
| MP 63 index | | Top 10 holdings* | | Paychex (PAYX, news, msgs) | | Medtronic (MDT, news, msgs) | | Harley-Davidson (HDI, news, msgs) | | Aflac (AFL, news, msgs) | | Avon Products (AVP, news, msgs) | | Johnson & Johnson (JNJ, news, msgs) | | BB&T Corp. (BBT, news, msgs) | | Intel (INTC, news, msgs) | | Illinois Tool Works (ITW, news, msgs) | | Philip Morris (MO, news, msgs) |
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*Note: As of Jan. 14, 2003
Source: MP 63 Fund
Manufacturers, however, account for 50% more of the MP 63 than the S&P 500 Index {$INX), and so-called New Economy companies are underweight by half. For instance, not a single software maker is represented. Few software companies even pay dividends, and those that do dont have good DRIPs, says Dave Fish, executive editor of The Moneypaper and co-manager of the mutual fund. (MSN Money publisher Microsoft (MSFT, news, msgs) announced its first-ever dividend only this month.)
Health care is about 30% underrepresented in the MP 63, while consumer-products companies such as Avon Products (AVP, news, msgs) have a double weighting. Even the number of stocks in the index, 63, is arbitrary -- chosen, Fish says, to stand out in a field of indexes that typically employ round numbers, like 30 for the Dow and 500 for the S&P.
Helpful limitations
These allocations have actually proved a boon in recent years, because the companies represented in the index have weathered the bear market better than most. The fund advanced 5.8% in 2000, slipped only 1.1% the following year and finished last year down 15%, nearly one-third less than the overall market.
The stocks were protected by their dividends, but they also tend to represent sturdy, market-leading companies. Two-thirds of the companies in the index have raised their dividends 10 years in a row, says Fish. Some have done that 30 to 40 years in a row. Thats a pretty good way to validate the fact the company has done well over time.
Dividends are associated mainly with value stocks, but Fish says the MP 63 index is intentionally tilted toward growth. That makes the mutual fund distinctly different than the equity-income type, a category that offers a yield about twice that of MP 63 Fund.
Equity-income funds are true value funds, with the average one sporting a price-to-cash flow of its holdings 23% less than the market, and average growth in three-year earnings 16% below market level. In contrast, MP 63 has an average price-to-cash flow ratio that is 4% higher than the S&P 500 and average growth in the earnings of the companies it owns that's 18% higher.
More growth means lower yields. MP 63 Fund yields about 0.75%, less than half the equity-income average. By the same token, the funds high expenses, 1.25%, gobble up the majority of its income. Were hoping to lower the expense ratio as assets rise, Fish says.
The preference of most
Most people who like DRIPs will prefer to invest in individual stocks, although the fund does offer the advantage of greater diversification. But most DRIPs require the account to be held in the name of the owner, and IRAs dont fit that mold -- they're held by trustees, such as brokerage firms and mutual fund companies.
Therefore, the fund is best suited to tax-deferred plans like IRAs, Roths and Keoghs. But it will also appeal to investors who find equity-income funds too tame and conventional growth funds too bold. One key to successful index investing is to find a good benchmark to follow, and MP 63 has been successful in both bear and bull markets.
Dont count on Congress to pass Bushs version of a dividend tax cut. But to this fund, that isnt crucial. Since the index already has demonstrated its success for nearly a decade, the fund is attractive already.
What they're buying now
Broadening its business: Paychex (PAYX, news, msgs), the funds largest holding, is a competitor to Automatic Data Processing (ADP, news, msgs) that specializes in small businesses. In addition to payroll processing, Its starting to get into retirement-account administration, Fish notes. The shares trade well below their 52-week high, and have fallen 27% in the last 12 months.
Its own mutual fund: Johnson & Johnson (JNJ, news, msgs) is one of the core-type companies we look for, Fish says. It dominates so many medical markets, its virtually a health care mutual fund in a single stock. J&J has grown its profits an average of more than 14% in each of the last five years.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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