Diving for Dividends

At a time when some believe that government bond yields are hitting the proverbial rock bottom and stock market volatility is more than many can stomach, where can an income-oriented investor turn? In a word: dividends.

In a low growth climate, high-quality dividend-paying stocks offer distinct attributes that make them a compelling antidote for wary investors. Alan Muschott, portfolio manager with Franklin Templeton’s equity group, explains how these attributes can help dividend-paying stocks outperform in grueling markets and what he looks for when picking companies:

“Nobody says they invest in low-quality stocks, right? Everybody says they invest in high-quality stocks. So what we really want to do is elaborate on what that means to us. The strength of what we do is in our research team and what most of their time is spent doing is really determining the quality of the company by looking at it from three different points of view.”

The rub with research is that results are largely contingent upon the methodology, so the question then becomes: what are those three points of view Alan and team focus on?

“First, we are looking at the business model and asking if the company has a sustainable competitive advantage. And if it does, that should show up in a growing market share or defending market share.  Then, the company has to be able to execute on that plan, so we look at management and all the way down the ranks.  Finally, we look at the financial aspects. We are looking for companies with strong balance sheets, strong cash flow and the ability to pay dividends and to grow the dividends over time.”

Interestingly, in a hybrid strategy there exists the flexibility to incorporate convertible bonds, a tactic which can help offset stock volatility. Convertible bonds offer the option of converting the bond into a certain number of shares of underlying common stock. The advantage to investors lies in the prospect of participating in good stock performance, with a fixed income component to soften potential downside:

“One of the strengths of our hybrid strategy is the ability to invest across asset classes, so we can move, depending on market conditions, increasing or decreasing our weightings in common stocks, convertibles and occasionally even straight fixed income. We look for convertibles that have historically experienced about 75 percent of the upside of the underlying common stock and only about 50 percent of the downside. In a volatile market, that helps dampen volatility.” 

With that, here’s your Sir John Templeton quote of the week:

“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”