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By Katie Rushkewicz Reichart, CFA | 06-20-2012 03:00 PM

Finding Dividends in Health Care and Energy

Westwood's Susan Byrne says the shop's funds have balanced lower-volatility health-care stocks with inflation-resistant energy names, while banking on a good history of dividend increases in both sectors.

Katie Reichart: I'm Katie Reichart, a fund analyst with Morningstar.

I'm here today with Susan Byrne, a longtime manager and founder of Westwood Holdings.

Susan is also sitting on the Quarter-Century panel today here at the conference.

Thanks for being here, Susan.

Susan Byrne: Thanks for having me.

Reichart: Susan, I know you're no longer involved in the day-to-day fund management, but obviously you're still following the market. I'm just curious, where you're seeing opportunities now.

Byrne: Well, I am involved, because it's a passion of mine, but we put together an excellent team. So, I am listening to what they are saying, but as someone that's trying to save, I am passionate about finding ways that you can save. And I think people in our funds are trying to find a balance between, let's say commodity companies that respond to inflation and also companies that can grow, and grow their dividend in the future, and trying to match those together to give you a good outlook on long-term returns.

Reichart: I know you have a lot of dividend-payers, especially in the health-care sector. I am just curious there, where you're seeing challenges for the individual companies?

Byrne: Well, I think in the health-care area, there is a real challenge [as] health care increasingly becomes a world market. And so, if you have been just a domestic pharmaceutical company, you haven't had the same distribution challenges.

At the same time, our American companies are going overseas. They're meaning quite good companies in growth markets. The American name and the American manufacturing system is well thought out, throughout the year, throughout the whole world. So that's good for them.

But the main thing we like about them is they have a lower volatility outlook, and they pay really excellent dividends. So, they may not be the fastest growers, but they are very profitable growers. And so, we can use those kinds of companies in the health-care area to balance some of our more commodity-type names, such as in energy, where they may respond positively to inflation, but in the near term might be more volatile.

So, we look at the health-care and energy as each having a role, but both of those categories do produce good current yields. And they also have a good profile and a good history for increasing those dividends over time.

Reichart: We have seen a lot of investors rush to dividend-paying stocks over the past few years, and I'm just curious, where do you think valuations are? Is that starting to get a little overheated?

Byrne: Well I think it depends on whether you're looking at a current yield or a future yield. Obviously, a current yield is what is a stock or a bond giving you today. And as there are companies that have nice, high dividends--maybe, they are in the utility area or in REIT area--and so they might give you a good current income, right now. But what are they going to be in five years and 10 years, which is really the challenge for investors today.

And so that's where stocks, a lot of them even in technology--a name like a Microsoft or even a Cisco or an Intel--these are companies that can grow their dividends in the future, and they can grow that dividend, let's say, at 10% to 15% a year. That's way ahead of inflation. And so that means your current income, while not maybe so high right now, is higher compounding at 12%, 10%, 15% in the future. And that helps you have an income higher than inflation, because when you're going to retire or when you're going to need that college money or for your own health-care needs, you're really going to need those five- to 10 years down the road.

So, that's the balance. And the overvaluation might be skewing in the utility and REIT, and they are not overvalued, but let's say fully valued. And the undervaluation, we can look for in some of these technology names balanced by health care and energy.

Reichart: What kind of advice do you give to newer analysts or portfolio managers?

Byrne: I think the hardest thing to do is to stick to your discipline. We've talked about that at this conference, for people who've done this for a long time. It's not getting trapped by saying, "Gee, I thought that a month ago, therefore, I must think that today." It's very, very hard to change your mind.

And the other thing to do is that when something is wrong, it's not what you thought, have the discipline to sell it, and those two things seem simple. They are extremely hard to do, but I think they are the hallmarks of good long-term investment strategy.

Reichart: Well, Susan, thanks so much for being here today.

Byrne: Thanks for having me, Katie.

Reichart: I'm Katie Reichart with Morningstar.

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