Manager Jill Evans thinks dividend-paying stocks will fare well this year.

    Although dividends have taken a back seat to the growth component of stocks in recent yearBolds, Jill Evans thinks that a more subdued market environment and juicier payouts by companies will increase their appeal.
    "Historically, over half of the stock market's returns have come from dividends," says the manager of the Alpine Dynamic Dividend Fund, which ended 2004 as Lipper's top-performing equity income mutual fund for the year. "I believe we are moving toward that historical norm again."
    Despite Evans' forecast, the new era of dividend investing that some predicted after the tax on qualified dividends dropped to 15% has only partially materialized. Even after a surge of dividend boosts by companies over the past two years dividend payments still represent less than 2% of the value of the Standard & Poor's 500 Index, so investors still need a healthy dose of growth to beat low-single-digit returns. And while dividend-paying stocks outperformed nondividend payers last year, their dominance prevailed only until September; a dividend cushion looked appealing as investor confidence sagged, but nondividend-paying growth stocks outperformed as optimism crept back into the market toward the end of the year.
    Evans thinks the stage this year is being set for modest stock market returns, and that bodes well for defensive, dividend-paying stocks. "When the stock market is growing 20% in a year, no one wants to hear about dividends," she says. "But with investors looking at the possibility of single-digit returns in 2005 and 2006, dividends are looking a lot more attractive."
    Industry fundamentals are also strong, and Evans believes that many traditional dividend-yielding companies, like industrials, materials, consumer staples and utilities, will benefit from a weaker dollar, continued penetration of global markets, improved balance sheets and operational leverage following years of restructuring. Strong free cash flow in 2005 will add to the record levels of cash already on corporate balance sheets. Although some companies will use cash to finance acquisitions or other growth opportunities, a substantial number will finance share buybacks or increase dividend payouts. Many of them are well-positioned to do so. According to Standard & Poor's, companies in the S&P 500 Index currently pass on 34% of their earnings in the form of dividends, versus an average payout of 54% historically.

A Bowl Of Stew
    Investors who agree with Evans' bullish view for dividend-paying stocks should be aware that this fund's formula for mining them is very different from the vast majority of its equity income competitors. Evans looks beyond the usual roster of steady cash generators in the pharmaceutical, utility and financial sectors to ferret out less obvious choices that are declaring an unanticipated special dividend, or even those paying them for the first time.
    She also moves into lesser-known small-company stocks with fat yields. To capture as much income as possible, she will trade around a stock's ex-dividend date while holding the security long enough for its dividends to qualify for reduced federal tax rates. "I look at the portfolio like a bowl of stew," Evans says. "The large-company steady dividend payers are the base of the stew, the meat and potatoes. The small-caps, special situations and trading strategy are the vegetables and spices."
    The Alpine Dynamic Dividend Fund portfolio is divided into three different investment strategies. The "dividend capture" side contains consistent, high-yielding stocks or special situations where large cash balances are being returned to shareholders in the form of one-time special dividends. To enhance returns, Evans may rotate a portion of the holdings after the 61-day ownership period required to obtain the 15% dividend tax rate. The primary goal is generating yield rather than capital appreciation, and Evans estimates that two-thirds of the fund's yield comes from this side of the fund.
    The core growth and income section contains stocks that have slightly lower dividend yields and predictable earnings streams, plus a catalyst for capital appreciation and potential dividend increases. "These are the kinds of traditional stocks you'd see in many growth and income portfolios," Evans says. "They have the potential to grow earnings 10% each year and to raise dividends at about the same pace. With capital appreciation, we're looking for about a 10% return from this side of the portfolio."
    In addition to familiar large-company names in the pharmaceutical and financial sectors, the growth and income section also contains a number of small-and mid-cap stocks. Rocky Mountain Chocolate Factory, which went public in 1986 and has a $72 million market capitalization, had a 4% yield when Evans purchased the stock about a year ago. After a rise in the stock price from $8 to $17 over that period, the yield is down to a little under 2%. "This company should grow earnings at a rate of 15% to 20% a year, and management is committed to raising the dividend as earnings grow," says Evans. Another small-cap cash generator, Meridian Bioscience, has a $240 million market capitalization and the potential to grow earnings at a rate of 15% to 20% a year. The company makes tests that instantly detect strep throat, influenza and other illnesses.
    Finally, the "value with a catalyst" side contains undervalued or turnaround situations where high dividend yields are a product of depressed earnings that Evans believes are poised to recover. Basset Furniture and Dow Chemical fall into this category.
    The fund's investment strategy has produced some of the beefiest dividend payouts in the industry. Based on a trailing 12-month dividend of $1.15 and a net asset value of $12.78 on December 31, the fund's yield in 2004 clocked in at 9%. About 96.5% of dividends distributed to shareholders qualified for the 15 % tax rate.
    This year Evans is targeting an annualized "floor" yield of 5% to 6%, although she says it could go higher if a lot of companies in the portfolio make unanticipated dividend announcements. Top fund holdings that declared special dividends last year include oil tanker company Frontline, Regal Entertainment Group and Microsoft. A recent purchase, oil transportation services company General Maritime, announced plans in late January to initiate quarterly dividends beginning in April. "Oil tanker companies like General Maritime and Frontline are huge cash generators," says Evans.
    The fund distributes dividends every month, rather than every quarter. The practice answers the call from shareholders who want frequent payouts, but could complicate record keeping for taxable investors. Those investors may also want to keep an eye on a trading strategy that produces a portfolio turnover rate of nearly 200%. Although Evans says that she's trying to stay around that threshold, the prospectus warns "the annual portfolio turnover rate of the Fund may exceed 200%." Thus far, tax-loss harvesting and other tax management strategies have been effective in helping minimize capital gains distributions. In 2004, the fund distributed 24 cents a share in short-term gains and 4 cents in long-term gains.
    Evans's view as an industry outsider may help explain the fund's unorthodox approach. She joined Alpine Woods, a firm headed by the father-and-son team of Stephen and Samuel Lieber, in May 2003. Before that, she was the senior equity research analyst covering small- and mid-cap basic industries at JP Morgan Securities, where she had worked since 1988. She was also the global coordinator of the firm's passenger and freight transportation sectors.
    "My career as a sell-side research analyst involved analyzing companies and forecasting earnings, and I had a lot of experience with dividend-paying industrials," she says. "So a switch to the buy side at a firm known for investing in income-producing stocks seemed like a good fit."
    Soon after she joined Alpine, President Bush announced the dividend-tax cut. "I looked at some databases and was shocked to find that the vast majority of funds yielded no more than the S&P 500 Index," she says. "Here the government was making this change that was a huge windfall for investors, but there was no way to capitalize on it in the universe of mutual funds."  Evans and the Liebers set out to change that with the launch of the Alpine Dynamic Dividend Fund in September 2003.
    The sunset provisions attached to the dividend-tax cut that fueled the fund's launch mean it is set to expire in December 2008, but Evans remains hopeful that won't happen. "If something has to go, I think it will be the capital gains tax cut because it's viewed as a rich person's benefit," she says. "Dividends are perceived as a benefit for the middle class. People are looking for an added measure of safety and security from the stock market. I believe there will be a secular shift to dividend-paying stocks with or without the 15% tax rate."