Don Taylor, senior vice-president of Franklin Advisory Services, says that the U.S. equity market is currently overlooking the merits of steady earnings growers that have been rewarding their shareholders with consistent dividend increases over many years.
"At present, the market's emphasis is on the more cyclical higher-risk names that respond to the early stages in an economic recovery," he says. "The valuation on steady earnings and strong dividend growers is attractive, and this is the area of the market that I focus on."
Taylor joined Franklin Templeton Investments in 1996. He is the lead manager of Franklin U.S. Rising Dividends (assets $407 million) out of Fort Lee, New Jersey. "Stocks with rising dividends tend to be less volatile than the rest of the market and have outperformed the market over the long term," he says. Also, these companies are subject to more stringent financial discipline, since they must make regular dividend payments to shareholders.
Taylor and his colleagues use quantitative screens to "narrow the list of dividend growers to consider." The target company needs to have raised its dividend in eight out of the past 10 years, with that dividend at least doubling during the period.
The dividend-payout ratio (the percentage of earnings paid out in dividends) must be "conservative." It should be no more than 65% of earnings, and "the sweet spot is 20% to 50%," Taylor says.
This helps to ensure sustainability of the dividend and leaves sufficient cash for reinvestment in the business. On valuation, the stock should trade at the low half of its historic range for price/earnings multiples.
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| Don Taylor | |
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After the company has passed these quantitative tests, the next stage, says Taylor, involves "the art of investing." Can the company maintain its historic dividend growth or even enhance it? Typically, he says, the companies that hold the most promise are leaders in their field that generate a high return on equity, have strong balance sheets and are consistent earnings growers. That is, they are less economically sensitive.
Such companies are to be found, for example, in health care, "excluding those pharmaceuticals that are vulnerable to a patent-expiry cliff," in consumer staples, and in chemicals where the demand is steady and growing. The industrial and technology sectors will also yield some picks.
In Franklin U.S. Rising Dividends, health-care-related stocks represent some 22% of the fund. "This sector is currently out of favour and offers good opportunities," says Taylor. The fund has 46 names, which, on average, have increased their dividends for 28 consecutive years.
A top 10 holding in the health-care sector is Abbott Laboratories Inc. ABT. Founded in 1888, this company, with a global reach, has three main businesses. They are pharmaceuticals (mainly biologics which come from a variety of natural sources and are harder for the generics to reproduce), nutrition and medical devices.
"It is a significant player in all these businesses and has a growing emerging-markets presence," Taylor says. Abbott has, for example, a major operation in India.
The company, says Taylor, has raised its dividend for 39 straight years and it more than doubled the dividend, with a 129% increase over the past decade. "Abbott has a solid balance sheet and is a strong free-cash-flow generator."
The stock trades at almost 11 times earnings per share estimates for 2011. This multiple is at the low end of the P/E range for Abbott for the last 10 years of 11 to 26 times.
A health-care stock, also in the fund's top 10 holdings and that is one of Taylor's longest-standing holdings, is Becton, Dickinson & Co. BDX. This global medical-technology company, which manufactures a range of products including medical devices such as syringes, and diagnostic equipment, was founded in 1897. "It has maintained its lead in its core markets and expanded into related markets," he says. "It has stuck to its knitting."
Becton, Dickinson has been raising its dividend for 38 consecutive years. The last dividend increase was in November 2010. At that time, it was raised by 10.8% to US$0.41 per quarter for an indicated annual dividend of US$1.64 a share. The dividend-payout ratio is 29%. The stock trades at a P/E multiple of 14.4 times its 2011 earnings-per-share estimates, versus its range over the past decade of 13 to 22 times.
The fund also has a holding in Johnson & Johnson JNJ, one of the world's most diversified health-care companies. This 123-year-old company has increased its dividend for 48 years in a row, says Taylor. "It is expected to announce another dividend hike later this month, making it 49 years of consecutive increases." The dividend-payout ratio is 44%. The stock trades at 12.3 times 2011 earnings-per-share estimates versus the 10-year historic P/E range of 10 to 32 times.
| Abbott Laboratories | Becton, Dickinson and Co. |
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| April.12 close | $51.03 | $81.37 | $58.94 | |
| 52-week high/low | $53.75-$44.59 | $85.90-$66.47 | $66.20-$56.86 | |
| Market cap | $79.0 billion | $18.0 billion | $163.9 billion | |
| Total % return 3Y* | 1.7 | 0.2 | -0.1 | |
| Total % return 5Y* | 6.9 | 6.9 | 3.6 | |
| Total % return 10Y* | 4.6 | 10.1 | 5.0 | |
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| *As of April 12, 2011 All figures are in U.S. dollars Source: Morningstar |
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Turning to other sectors, Taylor says that the transformation of International Business Machines Corp. IBM some 15 years ago into a more consistent cash-flow generator made the stock eligible for Franklin U.S. Rising Dividends. IBM is in the fund's top 10 holdings.
"The company diversified away from the computer-hardware business into software products and consulting services, and has raised its dividends for 15 years in a row plus making significant share repurchases." Its dividend payout ratio is 20%. The stock trades at 12.5 times 2011 EPS estimates versus the historic eight to 32 times.
A stock that ceased to meet Taylor and his colleagues' criteria and was sold is Nordson Corp. NDSN. An industrial company, Nordson has had a long history of dividend growth, "but this growth has slowed so that the dividend was up 50% over the last decade, when we require a 100% increase." Also, he says, "the stock's high valuation is predicated on expected earnings growth in a more cyclical area of its business, and our view is that this growth is not sustainable."
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