MARKET COMMENTARY

Choosing Companies That Endure With Success

Nick Getaz in New York City and Matt Quinlan in San Mateo share the ongoing legwork and insights behind a portfolio with built-in resilience.

04.23.2020

How are you managing? It’s an important question these days among friends, families and businesses. It’s also what we asked Matt Quinlan and Nick Getaz, co-lead portfolio managers of the Franklin Rising Dividends portfolio. See how upfront decisions are shaping their expectations for the road to recovery.

Matt Quinlan: Resilience is the hallmark of this portfolio and that starts with the research we do to determine whether a company meets our criteria as a good rising dividends company. Does the business have a strong management team, good capital allocation, an attractive margin profile and long-term growth opportunities?

Nick Getaz: Matt’s right; that first cut of the broader universe of stocks refines our investment opportunities into a more resilient subsector. Companies that, for instance, have achieved high single/double-digit dividend growth in at least eight out of 10 consecutive years, with no dividend cuts, have balance sheets with a long-term debt-to-capital ratio below 50%, or investment grade rate senior debt, and a payout ratio below 65%. The latter helps ensure companies are reinvesting.

Q: Why the emphasis on companies reinvesting?

Matt Quinlan: Our strategy is dividend growth focused, rather than focused on dividend yield. With this in mind, companies we hold tend to have very positive free cash flow generation capabilities in good and bad times. They continue to reinvest, improving their businesses annually through such means as introducing new products or increasing distribution. They’re moving to strengthen the business over time. That reinvestment comes back around to drive free cash flow and dividend growth.

This is distinct from some telecom companies or utilities, where you’ll see significant yields and higher payout ratios, but often lower growth.

 

Q: What factors are most testing the portfolio these days? 

Matt Quinlan: In this initial stage of the downturn, we’re clearly seeing the ripple effects of COVID-19 on the economy reaching smaller weightings such as some of our Financial names. Likewise, some Energy names—a very small part of the portfolio—have been feeling the further stresses of the Russia/OPEC market share war.

Nick Getaz: However, the portfolio’s largest weighting is in Industrials, where we have a cross-section of companies serving different end markets, often with innovation and technology growth drivers.

Standing in the midst of current volatility, it’s worth noting we look at things through a longer-term lens. For instance, we’re focused on how shorter-term interruptions are going to impair the business prospects of a company 10 years down the road. 

 

Q: With that in mind, how do you expect today’s environment to affect the long-term intrinsic value of the companies you hold?

Nick Getaz: We’ve seen a disproportionate response (i.e., the baby being thrown out with the bathwater) in share prices, which is not reflective of long-term prospects for many high-quality stocks. We believe the long-term intrinsic value of such companies will remain largely the same. There are a lot of market dynamics in play. We’re working to see through it all, looking at the quality of the businesses we hold and opportunities in the market.

Matt Quinlan: Take Lowe’s Companies, Inc., for example. It’s one of our newer names, operates in a very attractive sector and has undertaken a lot of internal change to improve its merchandise and supply chain. Though we’ve seen dramatic shocks to retailers due to COVID-19, does that mean people will stop investing in their homes? In the near term, perhaps yes, but over time we expect home improvements will absolutely continue. We see Lowe’s as offering significant long-term value, but it has definitely been pressured recently.

 

Q: To what degree do you expect holdings to preserve or grow their dividends?

Nick Getaz: Our expectation is always that our companies should be able to maintain dividends along with the required growth rate. A company decreasing or flattening its dividend growth rate for a period typically raises a red flag for us. It doesn’t mean we’re forced sellers, but it does warrant further analysis on our part to ensure the stock remains a conceptual fit.

A good example is Becton, Dickinson and Company, a medical technology firm with over 45 years of consecutive dividend growth. We’ve watched their rate of growth come off a bit. But, a closer look shows it’s largely due to the company integrating several large acquisitions made over the last few years. 

Q: Is the market fertile ground yet?

Nick Getaz: We’re seeing opportunities to add to positions that we’ve been building and opportunities to add to long-standing positions disproportionately affected by recent volatility. Working with the dramatic market swings, we’ve been very active, balancing the need to be both judicious and nimble enough to take advantage of the opportunities in front of us.

 

Q: What triggers will suggest the market is starting to move on?

Matt Quinlan: I think we’re going to need to see some progress around COVID-19, less negative news and a declining number of cases. While we’ve seen aggressive fiscal and monetary measures introduced by government and the US Federal Reserve, respectively, I think the biggest trigger will be when there’s a sense that things are getting less bad, if you will. 

Nick Getaz: Some early signs will be when the market’s sensitivity to bad news greatly diminishes, we stop getting the short, sharp day drops and, over time, the market largely absorbs bad news. It’s a sign that a lot of the worst-case scenarios are starting to be priced in. Once we get to that point, there’s room to begin an upward climb. There’s always the risk of false rallies or episodes where the market bounces up quickly, only to slip back.

 

Q: How long will it take for the market to recover and investors to begin recouping losses?

Matt Quinlan: That timing is unknown. However, looking beyond the volatility, we believe the strong fundamentals companies had in place prior to the COVID- 19 will re-emerge over time—holdings such as Proctor & Gamble Company with 60+ years of consecutive dividend increases, or Roper Technologies, Inc. with 25+ years of the same. From a fund management perspective, I think we’ll look back at this time as affording us opportunities for a number of these high-quality names. That’s what we’re focused on.

Nick Getaz: The current question is: What kinds of companies do you believe will do a good job of digging themselves out of this hole and have the best shot at a robust recovery? Which management teams give you greater confidence they’ll find the optimal, strategic way through these conditions? Over time, it’s been shown that quality businesses answer that question in spades.

 

Matt Quinlan

Vice President

Portfolio Manager, Research Analyst

Franklin Equity Group

Franklin Advisers, Inc.

San Mateo, California, United States

 

 

Nick Getaz

CFA

Vice President

Portfolio Manager, Research Analyst

Franklin Equity Group
Rising Dividends Strategies
New York, New York, United States

 

Resilience is the hallmark of this portfolio and that starts with the research we do to determine whether a company meets our criteria as a good rising dividends company.”  Matt Quinlan

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