Q: Can you give a brief history of the fund?

Meydenbauer Dividend Growth Fund was founded on September 30, 2010 with Coldstream Capital Management, Inc. as the fund’s investment advisor. I joined Coldstream in 2003 and became the fund’s portfolio manager in 2007. 

At that time Coldstream was trying to decide how best to handle its equity portfolios. As a high net worth firm, Coldstream had separately managed accounts that were focused heavily on core growth—which was an earnings surprise, earnings momentum, large-cap offering. It morphed into a dividend growth strategy based on my background. Dividend growth was born in our current separate account style on July 1, 2008. 

We felt we needed similar offerings for our client’s smaller accounts and decided to do that through a publicly traded mutual fund. The Meydenbauer Dividend Growth Fund has exactly the same portfolio as the separately managed accounts. The current fund size is about $63 million. Its three-year total return through September 30, 2015 was 11.07% and its five-year return was 10.09%.

Q: How is the fund different from its peers?

Most dividend growth funds do not have a minimum yield requirement. They just want to see whether a company pays a dividend of any kind and they believe that dividend will grow. To qualify for purchase in our fund, stocks must have a minimum yield of 2%. 

Also, companies that increase dividends by 5% to 10% or more per year are attractive to us. Other dividend-grower funds buy stocks with a history of annual increases; in our fund, the dividend must increase by at least 5% a year over the last three years. 

It is important to us to identify companies that support dividend growth with rising cash flow. Utilities grow their dividends a little bit every year – but that is coming from the balance sheet, not from increased cash flow and earnings. That’s not what we want.

Many funds are almost closet indexers or are afraid of getting too far from a benchmark, whereas we have no sector requirements. For example, our fund has never owned a utility or REIT because, like utilities, their dividend growth isn’t supported by increasing cash flow. 

Finally, a manager’s effectiveness is measured over a three- to five-year period. This focuses the strategy on being in the right stocks with the right fundamentals that look technically okay and that are going to play out over the next two to three years.

Q: Is there any particular thinking behind the 2% minimum yield criteria?

The theory was to identify companies with at least an S&P 500 Index yield and put together a portfolio that provided a yield that was 40% to 60% more than the S&P 500. There’s nothing magic about 2%. In fact, the prospectus allows us to buy down to 1.8%, but we have never bought a company that didn’t yield at least 2%.

For a relatively small startup strategy like ours, having that yield criteria narrows the investment universe and makes it easier to identify stocks that are possible for purchase.

Q: How do you decide whether a dividend is safe?

First, it’s much more difficult with cyclical stocks than with consumer staples. For instance, there is very little chance a McDonald’s Corporation or a Procter & Gamble Co. will cut its dividend. The risk is they start slowing or even stop the growth of the dividend, and that would be a fundamental reason we would sell. 

Cyclical examples would be Chevron Corporation and ConocoPhillips, both multinational energy corporations we owned until we became concerned that oil was getting too volatile, the earnings were not assured, and dividend growth – if not an outright dividend cut – was certainly in question. Both had been good stocks, but we just didn’t like the way things looked any more so they were sold. 

When we sold ConocoPhillips on November 4, 2014, the stock was about $70 a share. Chevron had been sold a bit earlier. I think both calls turned out well.

Q: What core beliefs guide your investment philosophy?

Controlling risk and growing prudently over a long period of time guide the fund’s investment philosophy. It focuses on large capitalization companies that pay dividends and have strong growth potential. Our belief is that dividend-rising stocks are normally stronger companies with better balance sheets and will outperform most benchmarks with less risk.

We also try to be tax efficient, meaning we do not want people to pay tax on something they have not made any money on.

Q: What is your investment strategy?

For me to buy a stock, it must pass a fundamental screen and also look good on a chart. 

The fundamental screen identifies companies covered by Value Line research that yield at least 2%. Their performance through good and bad is analyzed, as are metrics including five-year growth of expected earnings per share, cash flow, and dividends. 

Figuring out when an underperforming stock will turn around is not something we do. Our technical screen uses a somewhat proprietary tracking system that involves a 13-week cycle, looking at price momentum and relative strength versus a benchmark, to identify stocks that are outperforming or beginning to outperform the market.

Q: What steps are involved in your research process?

I’m a member of a seven-person investment strategy group that meets weekly to discuss the state of the world from a top-down macro view – what is going on and why, what is happening politically, and what’s happening with interest rates, for instance. Macro calls are made with input from the group: Is the economy getting better or is the economy getting worse? How is it affecting consumers? Manufacturers? Exporters? Importers? What’s the international picture? 

As the fund manager, I rely on these macro calls to decide which sectors to invest in. For instance, if they indicated the country was entering a recession, I would be much less inclined to invest in cyclical companies and much more inclined to invest in a defensive sector like consumer staples.

To find companies within sectors, we use the Value Line Timeliness Rank. It measures the probable relative price performance of stocks in its universe and assigns them a rating of 1 (lowest) to 5 (highest). We consider stocks ranked 1–3 and run screens based on the 2% minimum yield criteria, then go through and check the fundamentals of each, and finally apply the technical screen before we make a move to purchase.

I am also cognizant of capital gains and losses, and how that may affect investors. In the fund, we will consider harvesting some losses to offset gains taken earlier in the year. Later, if I like an asset, I might buy it back or replace it with a similar stock in the same industry. 

Q: Can you illustrate your research process with one or two examples?

A stock we bought within the last month is Analog Devices, Inc., a semiconductor manufacturer. It became apparent that they were going to be an important subcontractor for Apple’s iPhone. The company pays a dividend of 2.8% so it’s well above our threshold. Moreover, the dividend is growing 10% per year, the company’s cash flow is growing at least 10% a year, and it has an excellent balance sheet. Plus, we think the economy is improving and consumers are benefitting from lower gasoline prices—so they may have money to buy iPhones at Christmas. 

The stock had fallen from the high $60s to the mid-$50s and we did not believe there was any fundamental reason for that to happen. We bought it under its 50-day moving average price, which is important to us. The stock had a relative strength rating at the time of purchase of 68, the 200-day moving average was still rising, earnings were expected to be up 23% for the fiscal year that ends this month and rise another 13% next year, and a likely dividend increase is coming within the next 90 days.

Another recent purchase to illustrate our research process is Ford Motor Company, the automaker. We have been in it for 90 days and have high hopes for the stock, but it hasn’t worked out yet. However, there is no reason to sell, and given its compelling story, we might add to our position.

Automobile sales are growing and interest rates are low, so consumers could afford to finance a new car. And Ford was coming out with an entirely new version of the Ford F-150, which is the number-one selling truck in America.

Other metrics that fascinated us were low gasoline prices and strong truck sales. The stock is trading at a low price-to-earnings (P/E) of 8 times expected earnings for this year and about seven times next year’s earnings. The yield on the stock is 4.3% and they are growing the dividend by 10% a year. It looked like the stock was beginning to pick up momentum in July as the new Ford F-150 was coming on. 

But the stock is down about 2 points from where we bought it. Only in the last 10 days has the market started to jump on Ford, as its sales were up 23% year-over-year in September.

Invesco Ltd., a large manager of mutual funds, is another stock we got into because we liked the market, and the company had good earnings and dividend growth. When we bought it a year ago, it had a reasonable P/E of less than 15, the dividend was increasing 10% plus a year, and earnings were rising. It met our fundamental screens and we thought the markets were going to do well. But because of what’s happened over the past 90 days – where really, really good performers earlier in the year became very poor performers – Invesco hasn’t worked out for us.

Again, we are not anxious to sell the stock even though it has dramatically underperformed. It is now trading at 11 times expected 2016 earnings, has a yield of 3.3%, and they are growing the dividend. 

Q: How do you construct your portfolio?

Portfolio construction starts with our investment strategy group and what our outlook is for the economy, interest rates, and the markets in general. Back in 2008, this was a very defensive portfolio. It was overweighted consumer staples so it had all the tobacco and food stocks. About three years ago we decided to become much more aggressive and get away from consumer staples.

The size of the portfolio is between 40 and 45 stocks so it’s neither overly concentrated nor too broad based. The minimum investment tends to be in the 1.8% area and the maximum in the 4% area. A red-flag system based on declining value over cost guides our sell discipline; the only hard-and-fast sell rule I have developed over the years is if a stock drops 15% in value in one day it’s automatically sold.

We had not owned banks because they all cut dividends in 2008 and didn’t have a history of dividend growth. As of two months ago we had five in the portfolio. We started by buying JPMorgan Chase & Co. in 2011; it was the first bank to pay a reasonable and increasing dividend. At that time our exposure to financial stocks came primarily through insurance companies and asset managers, until we jumped into BB&T Corporation and Fifth Third Bancorp on July 30, and SunTrust Banks, Inc. and Wells Fargo & Co. on August 13.

Banks have been clobbered due to a perception that the Fed isn’t going to raise interest rates any time soon, and bank profit margins were going to be squeezed. We believe the Fed will raise rates and that this has not been priced into bank stocks. They are all trading at P/Es of about 12 and providing dividends with yields of about 3%. To us, banks look like a reasonable place to be holding money until interest rates actually do rise – whether that is later this year or next year, the story should still play out.

Even though we’d been in it only a little while, we sold out of BB&T on September 18; we sold to be tax sensitive, plus we have a very similar exposure in SunTrust. 

Q: What does risk mean to you and how do you control it?

To me, risk combines a couple of factors. One is the risk of loss of principal and two is the risk of loss of income through a dividend cut or elimination. We have an effective process in place to cover the risk of loss of dividend. 

Concerning the risk of loss of principal, we do not have a mandatory sell discipline but do red flag stocks and put them on a watch list for possible sale. A stock is red flagged if it has underperformed the market and hit a new relative strength low within 13 weeks. 

This happened to the large international cyclicals we had been holding in the portfolio – some of them for quite some time – and as they began to underperform we sold them out of the portfolio. That is where the cash came from to shift to the banks we purchased this summer. We are currently holding 8% cash in the portfolio because I have identified three or four things I may buy over the next couple of weeks.

We are not afraid to take losses and do not ride things down forever. Until three months ago no stocks in the portfolio were more than 2% below what we paid for them. Obviously, with this last market correction that is no longer true and I do have several stocks on the watch list now.