Dividend Growth: A Hallmark of Quality More than Ever

Why select high-quality, dividend-paying stocks could be in demand in the aftermath of the COVID-19 pandemic.

    Nick Getaz, CFA

    Nick Getaz, CFA Vice President, Research Analyst, Portfolio Manager, Franklin Equity Group

    Matt Quinlan

    Matt Quinlan Vice President, Portfolio Manager, Franklin Equity Group

    Some market observers have speculated many companies could cut dividends as the COVID-19 pandemic continues to unfold. However, that doesn’t mean there aren’t still opportunities for yield-seeking investors, says Franklin Equity Group’s Nick Getaz and Matt Quinlan. They explain why they look for select high-quality stocks with a strong track record of dividend growth through a range of positive and negative economic conditions.

    Amid COVID-19-related economic turmoil, many equity investors have asked for our view on the prospects for widespread dividend cuts in the US stock market. It’s an understandable concern as recent media reports suggest upwards of 25% of dividend-paying companies in the S&P 500 Index could reduce their dividends, and we’ve already seen some high-profile names do so.1

    Broadly speaking, we think this trend of dividend cuts will likely continue for at least the near term, given the sharp decline in economic activity since the spread of the coronavirus. Many companies are likely to be more conservative with their cash until there’s more clarity on when the pandemic is over from an economic standpoint.2

    From a portfolio standpoint, it is hard to be completely immune from dividend cuts in this environment. However, we have thus far seen a limited number of dividend cuts, while at the same time we have seen several companies increase their dividends.

    Although we expect the overall dividend growth rate for our portfolio holdings to be lower than in recent years, we think the rate could still be considerably better than the overall market currently seems to be expecting. We’ve been monitoring commentary from many corporate management teams very closely during the first-quarter earnings season, and many companies we follow have announced they have every intention to maintain or grow their dividend.

    Finding Resilient Dividend Growers

    We believe our focus on select companies that have demonstrated the ability to grow their dividends through a range of economic environments puts our portfolio in a relatively stable position.

    Our investment process not only looks for substantial and sustainable dividend growth, but it also screens for robust balance sheets and a lower payout ratio—factors which are intended to protect against an overextended dividend program and encourage reinvestment in future growth. We also tend to look for less cyclical companies, which should be more financially resilient in challenging markets and, therefore, more able to sustain their dividends. We continue to think these select companies are likely to perform considerably better than the overall market from a dividend perspective.

    We also think it is likely we could see a slower rate of growth during the recovery period, much as we did after the global financial crisis. In our view, investors could place a premium on valuations of companies that can sustain and grow their dividends.

    We view a strong track record of dividend growth as a hallmark of quality. We think that when the dust settles in the aftermath of COVID-19, investors will demand quality more than ever before.

    During the recent downturn in the US equity market, the selloff was so steep and violent that many investors weren’t really differentiating between the quality of companies during the decline. As such, we used this as an opportunity to add investments where we saw high-quality companies sell off disproportionately.

    ENDNOTES

    1. Source: Barron’s, “S&P 500 Dividends Will Fall 25% This Year, Analysts Say,” March 30, 2020. Indexes are unmanaged, and one cannot invest directly in an index. Past performance is not an indicator or a guarantee of future performance. Important data provider notices and terms available at www.franklintempletondatasources.com.

    2. Often drawn from earnings, dividends are one way in which companies may choose to reward investors. They are typically cash payments made on a regular basis, such as quarterly or annually.


    What Are the Risks?

    All investments involve risks, including possible loss of principal. Value securities may not increase in price as anticipated or may decline further in value. For stocks paying dividends, dividends are not guaranteed, and can increase, decrease or be totally eliminated without notice. While smaller and midsize companies may offer substantial opportunities for capital growth, they also involve heightened risks and should be considered speculative. Historically, smaller- and midsize-company securities have been more volatile in price than larger company securities, especially over the short term.