By Jonathan Burton, MarketWatch
SAN FRANCISCO (MarketWatch) -- With General Motors Corp. cutting its hefty dividend, you might think that dividend-focused mutual funds would be taking a hit. But you'd be wrong.
GM /zigman2/quotes/205226835/composite GM +1.13% halved its quarterly payout on Tuesday, to 25 cents a share from 50 cents, effectively cutting its dividend yield to 4.4% from 8.8%. Such a draconian decision seemingly would be negative for the stock, but shares of the troubled automaker held up relatively well, losing 2.3%. See full story.
In truth, most dividend-oriented funds -- and stock funds overall -- don't have major individual stakes in GM. Those mostly value-oriented fund managers who've committed even a tiny portion of their portfolios to the stock are bent on potential capital appreciation. They're banking that GM's management can engineer a successful turnaround and lift the shares. For them, a cost-saving dividend cut -- which was widely expected -- only enhances GM's prospects.
"The cut in the dividend was the right move," said John Buckingham, manager of the Al Frank Dividend Value Fund , which counts GM among its 150 holdings. "We're more than happy to sacrifice 25 cents a quarter if it means we get our capital gains down the road."
For some fund managers, Tuesday's cut didn't go deep enough.
"They probably should've cut the dividend out totally," said Don Hodges, co-manager with son Craig of the Hodges Fund /zigman2/quotes/205895892/realtime HDPMX +0.12% . Hodges started buying GM shares in December and has since built a 1.6% fund position in the stock.
"I feel better about it knowing they've cut the dividend than continuing to pay it when they're not earning it," Hodges added. "It's probably something they should've done a couple of years ago."
Driving home a lesson
GM's cut, in fact, is a reminder that high dividend yield is not a cushion against risk.
"This is not bond interest," said Don Cassidy, a senior research analyst at fund researcher Lipper Inc. "This is a dividend that the board of directors has to decide every quarter that they can pay."
Dividends are not sacrosanct, as longtime shareholders of Eastman Kodak Co. can attest. Common stockholders are at the bottom of a totem pole that pays bond holders first, Cassidy noted.
"Too many investors tend to be backward looking," Cassidy said. "You can't just say they declared the quarterly dividend for the last 10 years, I guess they're going to keep paying it. Think about what the business conditions are."
Jill Evans looked under GM's hood, but the co-manager of the Alpine Dynamic Dividend Fund /zigman2/quotes/209436960/realtime ADVDX -0.50% concluded that neither the company's yield nor its business was appealing.
"A company cannot continue to pay out in dividend more than it earns," she said.
If a company pays an extraordinarily high dividend, there's usually a good reason. Most often it signals distress -- problems that can send shares into a tailspin.
"You never want to own a stock just for the dividend," Evans said. "It has to be dividend plus earnings and capital appreciation potential. Otherwise it's not worth it; you'll lose the dividend quickly if the stock price doesn't run up."
Going to the dogs
With Tuesday's move, GM is no longer the highest dividend payer among the 30 Dow Jones Industrial Average members. That distinction now belongs to wireless provider Verizon Communications /zigman2/quotes/204980236/composite VZ +0.46% , with a 5.1% yield, followed by another telecom, AT&T Inc. /zigman2/quotes/203165245/composite T +0.33% , which yields 4.9%.
GM's yield, in fact, is now below that of rival Ford Motor Co. /zigman2/quotes/208911460/composite F +0.14% , which offers almost 5% annually. Still, GM's payout is substantial enough to keep the stock as a centerpiece of a well-known investment strategy called Dogs of the Dow, which involves buying shares in 10 Dow components with the greatest yield.
Neil Hennessy, manager of the Hennessy Total Return Fund /zigman2/quotes/204748667/realtime HDOGX +0.31% and the Hennessy Balanced Fund /zigman2/quotes/210452156/realtime HBFBX +0.27% , holds GM stock as part of the two funds' Dogs of the Dow mandate, an investment philosophy he describes as "contrarian" rather than yield-driven.
Other value funds with meaningful GM holdings at the end of December included Longleaf Partners Fund /zigman2/quotes/202270593/realtime LLPFX +1.02% , TCW Galileo Dividend Focused /zigman2/quotes/205281353/realtime TGIGX +0.32% , T. Rowe Price Value Fund /zigman2/quotes/209574122/realtime TRVLX +0.11% and Kelmoore Strategy Fund , according to investment researcher Morningstar Inc.
Hit the road
Ironically, if GM does turn itself around, the shares could become more attractive to an expanding group of funds that buy stocks based on rising dividends. Research has shown that dividend growers outperform nongrowers.
"It shouldn't be a surprise," said Lipper's Cassidy. "A company that consistently raises its distribution is a company that's doing fairly well."
Being in a position again to hike dividends seems a distant hope for GM and its shareholders now, but value investors believe that patience ultimately yields results.
"Anybody who owned General Motors for the dividend had to recognize there was a high probability the dividend would be cut," said Don Hodges. "The important thing at General Motors is not the dividend. The important thing is they make money again."