Of Interest Rates and Dividends

We are continually asked if rising dividend stocks are more sensitive to rising interest rates than growth stocks. This is a good question for the times at hand because, as we have made clear elsewhere, we believe interest rates will trend higher in the coming year. The short answer is all securities are impacted by rising interest rates, at some level, because interest rates are in the denominator of all valuations formulas. But having said that, a good rule of thumb is that rising dividend stocks with higher than average yield and slow dividend growth (utilities and some REITs) are very sensitive to increases in long-term interest rates, while lower yielding, higher dividend growth stocks (ie, Johnson&Johnson and Procter and Gamble) are less sensitive to rising interest rates. The latter group, indeed, in many cases, have a negative correlation to rising interest rates--meaning that rising rates actually benefit them. This relative insensitivity to interest rates is one reason health-care, household products, packaged food, and some retail companies are considered to be "defensive" stocks. We have been adding companies from these sectors to our Rising Dividend Portfolio. We are seeing some shift to these kinds of companies in recent weeks. We believe there is more to come.

Coke OK

Coca Cola reared its tired old head and reported better-than-expected earnings this week, which lifted the stock almost 3%. Sales were a bit soft, but the good earnings were a welcome sight for the sore eyes that have watched Coke's demise over the last four years. Coke also announced a 12% hike in their dividend. The hike got very little news, but we think the dividend action is more important than the earnings report. Coke has been showing modestly improving earnings and dividends for the last year or so. But Coke has a history of painting their earnings, so the good earnings alone would not be all that impressive to us. The fact that they increased the dividend in line with earnings growth and at a higher rate than they did a year ago, gives us just the hint that Coke may, indeed, be turning it around. We have said that before and been wrong. This time the atmosphere surrounding the earnings report was much more upbeat than any for a long time. Coke is very cheap and a fallen angel on Wall Street. If they can put together a few more quarters of good sales and earnings, we suspect the Wall Street crowd who abandoned KO will come roaring back. We guess $50 per share is pretty easy pickings. We have said that before too. Hang in there!

Dividend Star

We believe that in the case of many companies -- so goes the dividend, so goes the stock. This is an easy thing to say, but it flies in the face of the efficient market theory crowd who believe that it is impossible to predict stock prices. They hold that, while it may be said that stocks in general will grow 9-10% per year, it is not possible to ascertain the value of any particular stock. We think that is balderdash, what ever that means. Johnson and Johnson (JNJ) is a good example of what we call a dividend star. They have paid a dividend every year since 1944. They have increased their dividend for 40 consecutive years. JNJ's 10-year compounded dividend growth rate is 15%, their 5-year growth rate is 15.4%. Over the past 18 years, the stability of JNJ's dividend has been approximately 90%. During the same time, the correlation between its price and dividend has been 93%. JNJ is uniquely a company that from a historical perspective we can say, so goes the dividend, so goes the stock. As of 2/7/2005, our dividend model indicates the fair value of JNJ is approximately $75. JNJ is currently trading at $65. You do the math.