Mutual Funds: Dividends are draw
NEW YORK – With the stock market having jitters after a strong run-up in the past year, some investors might want something more low-key.
Dividend funds, though still subject to the vagaries of the stock market, can give comfort to investors looking for more defensive arenas.
While dividend payouts have increased in recent years, thanks in part to federal tax cuts enacted in 2003, many of the large, established companies that are traditional dividend payers are sitting on record levels of cash. That makes it easier for them to pay dividends and repurchase shares.
The large-capitalization stocks that are typical dividend providers, like those that populate the Standard & Poor’s 500 index, operate differently than startup companies that might be forced to reinvest most of their cash flow to support a nascent business.
Donald Taylor, a portfolio manager for the Franklin Rising Dividends Fund, looks not only for companies that make steady payouts, but also, as the name implies, for those operations that are likely to boost their payments.
The fund screens for companies whose dividend has at least doubled over the past 10 years, though he notes the approximately 45 stocks that make up the fund have done better than that: On average, the dividends have increased 22 years in a row.
Not surprisingly, many of the types of stocks that meet the fund’s requirements are industrial, financial and consumer companies – traditional dividend payers.
In recent years, Taylor noted corporate earnings and cash flow have remained robust, giving many companies ample room to pay a dividend.
“Operating margins have been very strong and companies have been relatively cautious in reinvesting, so that leaves free cash flow strong,” he said. “That leads to more and larger dividend increases and share repurchases.”
Taylor wants to first see that companies will remain consistent dividend payers. He noted that companies long known for their cyclical nature, such as energy utilities, have improved their dividend records in recent years but haven’t yet proved themselves for an adequate amount of time to merit inclusion in the fund.
“If it stays strong long enough, it’s going to meet my screen,” he said, referring to the parameters by which he evaluates stocks. “The companies that screen the best are the ones that can grow their business with relatively little capital investment. If it’s relatively modest, then that leaves more to be returned to the shareholders in the form of a dividend increase.”
Taylor cautioned that he avoids companies that boost their dividend payments at the expense of growth.
“What I’m not looking for is the dividend growing because of a big change in the payout ratio,” he said. “Although there are certainly times when it’s appropriate, it still has to be in the context of seeing the business grow in the longer term.”