John Linehan, lead portfolio manager of the $19 billion T. Rowe Price Equity Income fund (PRFDX), spends a lot of time thinking about dividend stocks. But with the S&P 500 index (.SPX) having returned about 40% over the past year, he is concerned that many investors aren’t paying enough attention.
“When the capital appreciation dwarfs the yield, it’s very easy to neglect the yield,” Linehan tells Barron’s.
A stock’s total return has two components: price appreciation and dividends. The former has handily outpaced the latter recently as investors grow more optimistic about getting past Covid-19 in the U.S.
On a longer-term basis, however, yield is important, says Linehan. “If we think about a more normalized market environment where the market’s up 6% to 10% [annually], yield can be a considerable part of that,” he says.
Today, the number of attractive stocks yielding more than 4% has “clearly diminished” versus a year ago, Linehan says, but “you can still selectively buy really good companies with attractive fundamental and valuation characteristics as well as a reasonable dividend yield.”
Linehan looks for dividend-paying stocks “with exposure to a recovering economy where you’re not having to pay a lot in terms of historical [valuation] multiples.”
Top holdings in his fund recently included banking giant Wells Fargo (WFC), which cut its dividend last year; insurer MetLife (MET), and utility Southern Co. (SO). Over the past year, the fund has returned about 45%, placing it in the top 30% of Morningstar’s large-cap value category. The fund yields about 2.4%.
Linehan doesn’t necessarily remove a stock from his fund after a dividend cut. Last year, for example, one of the fund’s holdings, Weyerhaeuser (WY), reinstated its quarterly dividend at 17 cents a share, down from the 34 cents where it had been previously. Linehan maintained his holding and added to it.
“It’s a real mistake to sell a company just because the dividend got cut,” he says. “Oftentimes, that’s reflected in the stock price.” Weyerhaeuser recently was at about $34, versus $27 and change right before the cut was announced.
Among the sectors the fund is overweight on are financials and utilities.
The financials sector, he says, is “one of the few areas where, relative to more historical norms, it’s still trading at a discount, and you have positive exposure” to an economic recovery.
The fund’s holdings in that sector include Fifth Third Bancorp (FITB), a large regional banking company based in Cincinnati. The stock yields 2.8% and trades at 11.2 times the consensus FactSet profit estimate for 2021 of $3.40 a share.
Linehan expects Fifth Third to benefit from rising interest rates, which help boost net-interest income, and good credit quality in the company’s loan portfolio.
The fund is also overweight utilities, which aren’t cheap but which Linehan believes are undervalued in certain cases.
Many utilities, he says, offer a way to play the growing shift away from carbon-based fuels toward using electricity more widely as part of the trend in green energy.
That includes Southern, which yields 4.3%. Its nuclear-power plant under construction, however, has had delays and cost overruns.
“That’s more than reflected in the stock price currently,” says Linehan. “The longer your time horizon, the more opportune an investment Southern is; those intermediate-term issues will be solved.”
As Linehan sees it, the yields for Southern and other companies are getting overlooked by too many investors focusing too much on upward prices.
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