There are signs that investors are turning their attention away from the high-growth stocks that have driven the US bull market in recent years, according to Nick Getaz and Matt Quinlan of Franklin Templeton, who say they are beginning to focus more on dividend-payers instead.
Over the past three years, high-growth stocks such as the FAANGs have propelled the US equity bull market to record highs, performing better than the overall equity market even during periods of geopolitical uncertainty.
However, Getaz and Quinlan, portfolio managers at Franklin Templeton, point out there have been signs in recent bouts of volatility that growth-focused investors are starting to view these stocks differently.
“As US-China trade frictions continue and global economic growth shows signs of slowing, the market seems to be more interested in stable companies with a proven track record of consistent dividend growth,” the managers said.
This is something that feeds into Getaz and Quinlan’s strategy of investing in companies with a track record of substantial and sustainable dividend growth.
The pair clarified that, while this process can be used to offset market volatility, they do not consider themselves “defensive investors”. Below they clarify their reasons for looking at income-paying companies to deliver long-term capital growth.
Companies with rising dividends outperform
This disparity between a high-yielding company and one with the potential to raise its dividend is key to Getaz and Quinlan’s process.
The managers said that while quality high-yielding companies may be attractive alternatives to investing in the bond market, they often don’t provide the sustainable growth prospects of companies with rising dividends.
“According to our research, rising dividends companies tend to experience greater long-term stock price appreciation versus companies that only maintain their dividends or don’t pay one at all. They also tend to experience less volatility over time compared to those companies,” they said.
“We believe that these performance characteristics are a result of the strong business models and management teams committed to paying an increasing dividend through the ups and downs of the business cycle.”
Companies with rising dividends tend to be “market leaders”
The second reason behind the managers’ preference for these companies is that they tend to be “market leaders”.
They said the companies that meet their dividend-growth requirements tend to start with a strong advantage, and their main focus is identifying which of these qualifiers are best positioned to maintain and increase this competitive advantage going forward.
To find these, they look for companies that are market leaders in their niche, have secular growth opportunities and have management teams that have demonstrated “sound capital decisions, including investing future growth and an increasing dividend stream to investors”.
They also have a five stage screening process where they look for companies that have demonstrated: consistent dividend increases, substantial dividend sources, a willingness to reinvest earnings for future growth, a strong balance sheet and that are available at an attractive share price.
Companies with rising dividends are popping up in more sectors
The final reason why Getaz and Quinlan are becoming more optimistic on companies with growing dividends is that there are now more to choose from.
“Since the financial crisis of 2008-2009, we have seen a much broader, more diverse group of companies qualify as dividend growers,” they explained. “Before the crisis, financial companies played a larger role in the category, but in the midst of the crisis, many banks cut or eliminated their dividends.”
While financials have largely recovered form the crash, the managers said they have morphed into what they call “dividend achievers”, only just catching up with other sectors such as technology which have been involved in dividend programmes since the early 2000s.
“We believe the combination of demonstrated dividend growth and strong business models, along with sound capital allocation, should drive increasing profit and free cash flow growth. This, in turn, tends to drive future investment in the next leg of growth, repeating the virtuous growth cycle and generating a sustainable and substantially growing dividend stream.”