These 2 dividend-stock funds use different strategies that work well in tough market times
By Philip van Doorn
Matt Quinlan of Franklin Equity Group explains how he selects blue-chip stocks for long-term growth and higher income
The stock market’s harsh reaction to Federal Reserve Chairman Jerome Powell’s speech last Friday should serve as a reminder: Difficult economic times are ahead, and what worked during the bull market can be a dark path for investors who want to keep making money.
A focus on strong, competitive businesses that can remain profitable and “press their advantages during tougher times” is favored by Matt Quinlan of the Franklin Equity Group, who co-manages the Franklin Rising Dividends Fund and the Franklin Equity Income Fund .
He provided examples of such companies, while describing the two funds’ strategies.
Investments for an economy with higher rates
Over five years through 2021, the S&P 500 returned 133% with dividends reinvested, while its information technology sector more than doubled that performance with a return of 303%. That was, by far, the best return for any sector, and it reflected the times — liquidity was high and investors were exuberant about sales growth, even for companies that weren’t consistently profitable.
But times have changed. Following Powell’s comments predicting “some pain to households and businesses” that will result from the central bank’s efforts to slow the economy and bring down inflation, stocks took a broad tumble on Aug. 26. The S&P 500 is now down 14% for 2022, while the tech sector is down 19.5% (again, with dividends reinvested).
In a note to clients on Aug. 28, Odeon Capital analyst Dick Bove called Powell’s remarks “superb,” because they emphasized the Fed’s commitment to stabilizing prices and made clear that the path toward achieving this goal “would not be short but it would be upsetting.”
We may be in for a years-long cycle of elevated interest rates. That means continuing pressure against stock prices, especially for companies that are heavily indebted or have low profit margins.
Also on Aug. 28, MarketWatch’s Mark Hulbert wrote the following in his discussion of bull- and bear-market signals:
When bull market sentiment is predominant, investors tend to focus on short-term technical factors such as momentum, trend following and chart patterns. Only near the end of bear markets do they begin to focus on long-term fundamentals.
In a bull market, some investors may become day traders, hoping to make quick profits as companies do whatever they can to push sales estimates higher.
What may be best for investors now, at what may be the early stage of a years-long process to quell inflation, is a long-term focus on quality. Quinlan named two stocks as examples — both are long-term holdings of the Franklin Rising Dividends Fund: PepsiCo Inc. (PEP) and McDonald’s Corp. (MCD).
These companies may not inspire the imagination of the type of investor who got used to the good life of the liquidity-driven bull market, but look at the following summaries for each.
First, PepsiCo — the stock’s current dividend yield is 2.72%. That might seem relatively modest in an economy with 8% inflation, but it is much higher than the S&P 500’s weighted dividend yield of 1.63%, according to FactSet. Now consider how well this stock would have worked out if you had purchased it five years ago, based on data provided by FactSet:
That 74.5% five-year total return for PepsiCo is a bit behind the 79% return for the S&P 500 . But you might want to look at this chart — the ride has been much smoother for PepsiCo:
The chart shows how the S&P 500’s performance through 2021 moved in step with the vast increase in the money supply as the Federal Reserve and federal government continued their stimulus efforts. Now things have reversed, with the benchmark index falling 15% this year (with dividends reinvested), while PepsiCo is up 2%.
For Microsoft, the current dividend yield is only 0.94%, but its five-year dividend CAGR has been 9.7%. The dividend yield on shares purchased five years ago would be 3.39% and the stock has gained 263% in five years for a total return of 287% with dividends reinvested.
Growth and value strategies
The Franklin Rising Dividends Fund holds 55 common stocks and is benchmarked to the S&P 500. The fund is designed to be a “core” growth-oriented portfolio with low turnover, Quinlan said during an interview. The fund has $25.3 billion in assets under management and has a three-star rating (out of five) within Morningstar’s “Large Blend” category.
Over the past five years, the Rising Dividends Fund has returned 78%, slightly behind the S&P 500’s 79%.
Franklin goes through a screening process to winnow down all publicly traded U.S. companies to a group of about 325 that meet the management team’s criteria for the Rising Dividends Fund, including having investment-grade ratings for their debt and dividend payout ratios not exceeding 65% of earnings.
“Then we do our work from there” to use more subjective analysis to select stocks for investment, Quinlan said.
The $3.6 billion Franklin Equity Income Fund is “more yield-oriented,” according to Quinlan. It has a dividend yield of 2.57%, while the Rising Dividends Fund has a yield of 1.69%. The Franklin Equity Income Fund is benchmarked to the Russell 1000 Value Index and is rated four stars within Morningstar’s “Large Value” category.
In addition to common stocks, the Equity Income Fund also invests in convertible bonds and equity-linked notes, Quinlan said. He added that he and his colleagues focus on “qualified dividend income,” which means income that is taxed at the most favorable rate. A company might be distributing capital gains or even returning part of investors’ own capital as part of its dividend. So the Franklin team calculates its own yields for the Equity Income Fund’s investments based only on qualified dividends.
The Franklin Equity Income Fund has returned 59% over the past five years, compared with a 49% return for the Russell 1000 value index.
Reflecting their investment styles, the Rising Dividends Fund leans more toward technology and health care sectors, while the Equity Income Fund is more heavily concentrated in financial companies and utilities, Quinlan said.
“Times of uncertainty favor quality companies with proven business models and attractive cash-flow models that can continue to invest in their businesses through an economic cycle,” Quinlan said.
Funds’ top holdings
Here are the top 10 holdings of the Franklin Rising Dividends Fund as of July 31:
Company Ticker Share of portfolio Total return -- 5 years Microsoft Corp. MSFT 8.9% 287% Roper Technologies Inc. ROP 3.7% 83% Accenture PLC Class A ACN 3.4% 146% Analog Devices, Inc. ADI 3.4% 116% Linde PLC LIN 3.2% 140% Texas Instruments Inc. TXN 3.2% 136% UnitedHealth Group Inc. UNH 3.0% 190% Stryker Corp. SYK 2.9% 57% Raytheon Technologies Corp. RTX 2.6% 48% Visa Inc. Class A V 2.4% 101% Source: FactSet
Here are the top 10 common-stock holdings of the Franklin Equity Income Fund as of July 31:
Company Ticker Share of portfolio Total return -- 5 years Johnson & Johnson JNJ 3.5% 41% Morgan Stanley MS 3.5% 115% Chevron Corp. CVX 3.2% 90% JPMorgan Chase & Co. JPM 3.2% 45% Duke Energy Corp. DUK 2.9% 54% United Parcel Service Inc. Class B UPS 2.9% 100% Procter & Gamble Co. PG 2.8% 76% Raytheon Technologies Corp. RTX 2.8% 48% NextEra Energy Inc. NEE 2.7% 159% Medtronic PLC MDT 2.6% 25% Source: FactSet
Click on the tickers for more about each company, including news that drove prices lower on Friday. Then read Tomi Kilgore’s detailed guide to the wealth of information available for free on MarketWatch quote pages.
-Philip van Doorn
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