Where to Find Value in the Market

Resilient and overvalued. That is certainly one way to describe the Growth factor of the US stock market. With companies like Nvidia, Autodesk, Visa and Dexcom all trading at greater than 15x price to sales, a reasonable investor may consider the landscape a touch overextended. If you have invested solely in pure value equities, the past decade or more has been a difficult period for your portfolio. Value has steadily underperformed Growth across all market caps since mid-year 2007. However, within the Value category there are both qualitative and style factors that deserve our consideration. Factors that crossover into strong Growth names and remain respectful of traditional Value metrics. We believe these strategies satisfy modest levels of risk appetite and have performed well on both a relative and absolute basis. 

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One of these strategies is the dividend growth style factor. Now, what do we mean by dividend growth? For starters, the strategy aims to invest in companies that have steadily increased dividends over a specified period. In doing so, management has demonstrated a level of confidence in their earnings and subsequent future cash flows. Companies that qualify as a “dividend grower” likely have strong balance sheets, seasoned management, and the capability of sustaining the increase in dividends per share. To be clear, this is not a pure value strategy. Majority of dividend grower funds consist of Large and Midcap Value names and we believe this to be beneficial. However, to qualify as a dividend grower, you do not need to be considered a value stock.

Secondly, there is a big difference between dividend growth and high dividend yield. High dividend yield focused funds do not care for consistent growth in dividends per share. The objective of high dividend yield funds is to invest in companies that pay dividends that are higher than average. Naturally, these funds include exposure to sectors we are actively trying to avoid e.g. Real Estate & Energy.

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Lastly, Investopedia defines a value stock as “A stock that trades at a lower price relative to its fundamentals.” Pure value names tend to display the strongest value characteristics across all factors including book value, dividends, earnings and sales. As I previously stated, to qualify as a dividend grower the company does not need to be categorized as a value stock. Therefore, by investing in a dividend growth strategy, you are also gaining exposure to quality growth names.               

This brings us to our next factor. Quality. Without question, we live in a market-cap weighted world. A world where growthy stocks have benefited from the fundamental shift into more technologically focused and direct to consumer-based business models. Last week, Commonwealth’s Investment Management and Research team published a post in which they refuted the popular claim that today’s environment is a mirror image of the dot com era rise in growth valuations. Their argument is built on the notion that the economy today is vastly different from that of 30 years ago. Tough to argue with that, right? I mean just look at the change in S&P 500 sector weightings from 1989 versus today. It is absolutely mind-boggling how much has changed in 30 years!

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So, what does this have to do with Quality? Commonwealth’s Peter Essele, who authored the recent post, believes today’s market varies greatly to that of the dot com bubble. He believes that due to technology companies developing such superior business models, current valuations can be justified. Peter goes on to explain that technology companies of the 1990s had no earnings and very premature business models. For example, a company like Apple has developed a wide moat in their industry, proven to be sustainably profitable, and are known for consistently increasing their dividend. By participating in a dividend growth strategy, you by default are investing in both Quality Growth and Quality Value equities. We believe this to be a best of both worlds’ scenario. Just look at how dividend growers have performed relative to the S&P 500 Index. The out-performance speaks for itself.

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Dividend Growers and the S&P 500 Index: Growth of $10,000

In conclusion, a fund that focuses on dividend growth, gives you access to companies that satisfy traditional value metrics and provides exposure to quality growth names. We look forward to following up on this topic and as always would appreciate your feedback. In the months to come, we will be rolling out a video series including roundtable discussions between Neil, Rachel and myself. Topics will range from investment strategy to financial planning best practices. If there is a specific topic you would like us to touch on, please feel free to reach out. Your input is always valuable.

This material is intended for informational and educational purposes only and shot not be construed as investment advice, a solicitation, or recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.