Since the start of 2022, growing inflation and rising interest rates have contributed to a marked increase in market volatility. […]
Since the start of 2022, fears of recession, rising interest rates, high inflation, supply chain disruption and ongoing geopolitical conflict have unsettled financial markets, prompting widespread selling and volatility in the markets. With all the negative headlines recently, we have been getting questions about how we are positioning the portfolio in the current environment and what helps us stay calm in the face of uncertainty.
For our Guardian Global Dividend Growth strategy, at i3 Investments1, we always look for high-quality companies that we believe can provide sustained dividend growth, have stable earnings, solid fundamentals and strong opportunities for profit and growth. We believe that investing in companies with consistent and growing dividends can provide core building blocks to grow capital while managing risk over the long term.
In the current environment, with inflation, rising interest rates and slowing growth and earnings expectations, the case for owning, dividend-paying companies with consistent earnings growth, high-quality dividend payouts and cash flow visibility has rarely seemed stronger. We believe that companies like these—that are typically leaders in their sectors, with strong balance sheets, low debt, stable revenues and economic moats—are best positioned to sustain the deteriorating market conditions.
Why dividend growth matters
We believe a company’s ability to provide sustainable dividend growth is one of the cornerstones of wealth building, and it becomes even more important during inflationary periods and slowing growth environments. A steadily growing dividend is often a sign of a company’s durability, stability, and confidence in its underlying business. These are companies with pricing power that can protect their profit margins by passing those costs along to customers, such as Costco, Johnson & Johnson and Microsoft. These are companies with durable competitive advantages and strong brand recognition like McDonald’s and Nestlé. These are companies with stable earnings and strong balance sheets, with a commitment to return cash to shareholders.
We center our approach on finding resilient companies that can serve as the core building blocks of wealth creation throughout market cycles; companies that exhibit strong dividend growth, a quality payout and sustainable cash flow growth (often we refer to these attributes as Growth, Payout, and Sustainability or GPS). We believe that:
• Dividend growth is a significant factor for long-term returns and depends on consistent earnings growth
• A quality payout reduces volatility in share price movements
• Robust companies emphasize sustainable cash flow growth resulting in a low probability of dividend cuts
Needless to say, not all dividends are created equal, and that is especially true in the current inflationary and rising interest rate environment. A high-yielding company may look initially attractive, but they are often highly leveraged, with high payout ratios that offer little room for dividend increases and, in the first instance when things get rough, these dividends may even get cut.
This is why, rather than investing in companies based on yield alone, our strategy focuses on companies that we believe have the potential for strong dividend growth, which we call “dividend growers”, and companies that have an attractive, quality payout, which we call quality “dividend payers”. The tables below show examples of each in our Guardian Global Dividend Growth strategy and why we think they will continue to exhibit strong dividend and cash flow growth:
Examples of Dividend Growers in the Strategy
|Company||Dividend Yield||1-year DPS % Change*||Growth, Payout, Sustainability Attributes|
|Costco||0.75%||13.15%||• Strong sales growth potential with increasing memberships which drives repeat business and brand loyalty
• Strong long-term moat and pricing power benefits stemming from scale advantages
• Strong past and future dividend growth rates coupled with positive EPS growth expectations (according to our AI model)
|Microsoft||0.97%||10.71%||• Successful pivot from desktop to cloud computing continues to generate growth for the company
• Strong forecast dividend growth rate (according to our AI model)
• Continues to return cash to shareholders through dividends and buybacks
|United Health||1.28%||15.38%||• High-quality name with sustainable earnings and dividend growth and strong forecasted dividend growth (according to our AI model)
• Operates in the Healthcare sector that is less driven by the business cycle, and should be more resilient in the current environment
*As at June 30, 2022
Examples of Dividend Payers in the Strategy
|Company||Dividend Yield||1-year DPS % Change*||Growth, Payout, Sustainability Attributes|
|Total Energies||5.27%||1.14%||A French-based oil and gas company that has an attractive yield coupled with strong earnings and dividend forecasts (according to our AI model)|
|WEC Energy||2.89%||7.25%||A high-quality natural gas and electricity provider in the US Utility sector with positive forecasted earnings and dividend growth in a slowing global growth market (according to our AI model), an attractive dividend yield with lower volatility attributes|
|EPR Properties||7.03%||6.67%||A US REIT that focuses on experiential and educational properties, with strong forecasts of earnings growth with a low probability of earnings drop, along with its higher and sustainable dividend yield and forecasted dividend growth (according to our AI model).|
*As at June 30, 2022
In a world of slowing growth and heightened volatility in the markets, we believe that companies such as those we listed above, with strong GPS attributes, are well positioned to be resilient and weather the market turbulence. We constantly aim to build a diversified portfolio of companies with strong GPS attributes that can deliver growth on the upside, while also protecting against inflation, rising interest rates and global growth slowdown, which are heightened concerns for investors right now.
Concerns about inflation
Our aim is to invest in a portfolio of companies that can continue to grow dividends in a sustained fashion. In an inflationary environment, this often means looking for companies that can pass on some of the higher costs to the consumer. Companies like Costco, which can pass on inflationary pressures to the consumer through price increases, maintain strong margins and continue to do well in an inflationary environment. Our exposure to the Energy sector is another area that can mitigate some of the inflationary pressures. Overall, we believe that the anticipated dividend stability and potential growth can provide an effective inflation hedge.
Rising interest rates
There are two areas in the equity market where we currently see the most interest rate sensitivity: in the low-yielding, high-growth stocks with low near-term cash flow visibility, as interest rates impact their long-term growth projections of cash flows; and in the high-yielding bond proxy equities. As our portfolio does not invest in these types of companies, we believe that it is well-protected in a rising interest rate environment. We aim to invest in companies with quality earnings growth, rising cash flows and low cost of borrowing, which makes them less sensitive to interest rate moves. The portfolio is naturally geared towards companies where the certainty and visibility of cash flows are paramount. It is also well diversified across sectors, which we believe is key in reducing the interest rate sensitivity of the portfolio.
Growth and earnings deterioration
With evolving monetary policies, rising interest rates and valuations under pressure, we believe earnings will be critical to supporting equities and generating further gains. Against this backdrop, we believe focusing on our AI model predictions* for earnings growth and dividend growth will be even more critical. Our machine learning algorithms aim to forecast earnings and dividend growth and the probability of earnings and dividend cuts one year forward. We believe that this enables us to not only find the companies that are likely to be resilient in the slowing growth environment and continue to grow their earnings and dividends despite the headwinds, but also to avoid those companies that are likely to see earnings deterioration and dividend cuts, which is most crucial to dividend income seekers.
A ‘sleep well at night’ approach
We believe the portfolio consists of high-quality companies with strong fundamentals and are confident in the portfolio’s future prospects. Growth, Payout and Sustainability have always been our focus. Our approach does not look at equities by style or size, but by their ability to grow earnings and sustain a credible dividend payout. We believe focusing on companies with these types of attributes leads to strong risk-adjusted returns and reduced volatility.
Having navigated multiple volatility regimes and market cycles, we believe that our focus on quality companies with strong GPS characteristics delivers a ‘sleep well at night’ approach that aims to outperform the market through time with less volatility: an all-weather approach that can be used as core building blocks for wealth building in investors’ portfolios.
1:i3 InvestmentsTM Team is a portfolio management team with Guardian Capital LP, a registered portfolio manager.
*Based on a multi-factor algorithm incorporated into a proprietary analytics model. The application of a model is hypothetical and the simulated results are subject to inherent limitations.
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