Donald G. Taylor employs a series of proprietary screens to make stock picks for the $596-million Franklin U.S. Rising Dividend.
"We're absolutely focused on prospective dividend growth, the strategy, the historical record of dividend growth, as an indicator of what to expect," says Taylor, a senior vice-president for Franklin Equity Group, part of Franklin Templeton Investments.
Taylor has been the fund's lead manager since October 2005, working closely with portfolio managers Margaret McGee and William Lippman. The investment strategy is based on the same process as the rising-dividends mandate for U.S. investors that Taylor has been responsible for since June 1996. In all, he manages approximately $10.6 billion in assets under this strategy.
Taylor and his colleagues employ five screens to narrow the list of companies that meet the fund's criteria. The first screen focuses on consistent dividend increases, identifying companies that have increased their dividends in at least eight out of the last 10 years without a dividend cut.
The second screen identifies companies that have at least doubled their dividends over the last 10 years. "What we're really looking for are companies with 10% or so of dividend growth year after year," says Taylor. "On average, the companies in the portfolio have historically increased dividends for 29 years in a row."
The next two key criteria deal with the financial health and flexibility of the companies. This is an indicator of the sustainability of dividend increases. In the balance-sheet tests, for instance, the fund screens for companies whose ratio of long-term debt to total market capitalization does not exceed 50%.
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A similar screen is a payout-ratio test, seeking companies whose payout ratio per share is no more than 65%. The managers want to make sure that the companies are able to invest in the business. "As a result, our dividend growth comes from the business growing, which enables them to pay ever-increasing dividends," says Taylor, "not just because of payout ratios."
The fifth screen looks for out-of-favour companies that are trading at lower valuations relative to their 10-year price-to-earnings history. "So that's something of the value overlay on what's otherwise a kind of steady, conservative growth strategy."
The fund holds around 50 stocks, with no more than about 5% in any one holding. Although the mandate is tilted toward large-cap companies, there is a "meaningful position" in securities that have less than $10 billion in market capitalization.
From a sector perspective, the fund is currently weighted approximately 30% in consumer-related stocks and 21% in health care. Only 4.5% is in financial services, reflecting the fact that after the 2008-2009 credit crisis, many banks had to cut their dividends and no longer met the fund's criteria.
Illustrating the stock-picking criteria is Becton Dickinson & Co. BDX, a world leader in the manufacturing and distribution of medical surgical products, which Taylor bought for the U.S.-based fund in the summer of 1996. At the time, the company had 24 years of dividend increases.
"Today, the dividend has been increased 40 years in a row," says Taylor, "and that 23 cents a share that we had in 1996 is now $1.80 a share, and the stock price is $76 from $19. (All figures in U.S. dollars.) So the yield on the stock now is 2.4%, about my average." As long as the prospects for Benton Dickinson are seen as favourable to continue to grow the dividend, and "as long as it doesn't get too expensive," the stock will remain in the fund.
Taylor, 58, earned a bachelor's degree in economics from the Wharton School of the University of Pennsylvania in 1976. Upon graduation, he joined Tait, Weller & Baker as a certified public accountant. In April 1986, he moved to Fidelity Management in Boston, where his responsibilities included portfolio management. After leaving Fidelity in August 1995, he joined Franklin in January 1996.
Under Taylor's tenure, Series A of Franklin U.S. Rising Dividend has an annualized five-year return of 1%, compared with a 1% loss for the median fund in the U.S. Equity category. More recently, over the three-year period, the fund has returned 7.3% compared with 6.5% for the median fund.
"Not surprisingly," says Taylor, "subsequent to the '08-'09 period, our relationship with the risk analysts' team has been bolstered and enhanced." As well, "more qualitatively, if there's anything that the period taught us, it is to be well aware of scenarios that can develop. So we really spend a lot of time thinking about the range of outcomes, not just what we think the most likely outcome will be."
In positioning the fund for the future, "one of the appealing aspects of this fund is not just the returns over time, but the volatility, or the path to that return," says Taylor. "So the fund tends to outperform in down markets and underperform in up markets."
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