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Home>Research & Insights>Fund Times>A Prudent Approach to Dividend-Stock Investing

A Prudent Approach to Dividend-Stock Investing

Silver-rated Columbia Dividend Income favors companies generating steady, positive free cash flow.

Gretchen Rupp, 09/23/2017

The following is our latest Fund Analyst Report for Columbia Dividend Income GSFTX

A cautious process and an experienced manager earn Columbia Dividend IncomeGSFTX a Morningstar Analyst Rating of Silver. Lead manager Scott Davis follows a disciplined approach that favors companies that generate steady, positive free cash flow.

Davis joined the fund in 1998, became a comanager in 2001, and assumed the lead role following previous lead manager Dick Dahlberg's retirement at the end of 2013. The fund never skipped a beat. Risk-adjusted results land in the large-value Morningstar Category's top decile during his tenure as comanager as well as lead.

Davis' prudent approach is based on his view that a predictable source of cash is the best indicator of dividend payouts. He buys stocks that have a free cash flow yield in the top two quintiles of his selected universe. Davis works with two comanagers and Columbia's central research team to select companies with steady free cash flows and a disciplined capital spending program.

The team won't hesitate to sell a stock if they think fundamental changes, such as rising competition or debt, threaten future cash flows. The team, for example, sold Verizon VZ in June 2017 after holding it for 15 years because Davis believed price competition had undermined the advantage of its superior network. He now favors AT&T T because of its planned merger with Time Warner TWX.

The managers' valuation discipline sometimes causes them to sacrifice some upside. The team, for example, sold its position in video game publisher Activision BlizzardATVI in December 2016 because they thought its valuation was untenable, despite its healthy cash flows and dividend growth. Although this approach can cause the fund to trail its Russell 1000 Index in market rallies, the team's price discipline typically offers downside protection. Indeed, the fund has lost about 15% less than its bogy during down markets while Davis has been manager. Plus, the fund has been steadier than most with a standard deviation lower than 85% of peers over the same period.

Process Pillar: Positive | Gretchen Rupp 09/18/2017
This fund's managers look for firms with steady cash flows that lead to consistent, and sometimes increasing, dividend payments. The team downplays the importance of a company's payout ratio, although it is frequently cited by some rivals as a signal of dividend quality. The team says earnings are easily manipulated, so it monitors a company's ability to continue dividend payments using free cash flow yield--a company's free cash flow divided by its market cap. Indeed, by this measure, the fund has consistently stayed ahead of its index with an average free cash flow yield about 80 basis points above its bogy for the three years through August 2017. This focused approach is executed well and earns the fund a Positive Process rating.

The team starts by ranking companies in quintile groupings, based on free cash flow yields, selecting stocks from the highest two quintiles. The team says stocks with very high dividend yields are often from lower-quality firms that can't support the payment over time, which is why it focuses on companies' cash flow. The team evaluates the firms' capital-allocation decisions, including share repurchases, acquisitions, and debt repayment. The team's priorities are apparent in the fund's average return on invested capital, which was about 20% higher than its index during the three years through July 2017.

Gretchen Rupp is an analyst covering fund-of-funds strategies on Morningstar’s manager research team. 

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