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By Laura Lallos | 02-09-2015 10:00 AM

In Search of Sustainable Dividends

Make sure the dividend a company is paying today isn't coming at the expense of future payouts or the future growth of the business, says Silver-rated JPMorgan Equity Income manager Clare Hart. Plus, the case for domestic tobacco and energy.

Laura Lallos: Hi, I'm Laura Lallos, an analyst here at Morningstar. I am speaking today with Clare Hart, the longtime manager of JPMorgan Equity Income Fund (OIEIX). Clare, thanks for joining us.

Clare Hart: Thanks for having me.

Lallos: I think it would be useful [if you started by explaining] your approach to equity-income investing because it's not about the highest-yielding stocks for you.

Hart: So, for us, in this strategy and the portfolio, the way we do it is, first off, we call it the equity-income fund, and that's on purpose. We're equity, so we're not using fixed income, we're not using derivatives, or synthetics of any kind. It's really about equities, and the income piece comes from the companies in the portfolio. So, we look for what we call quality companies at a reasonable valuation that pay a dividend yield. And we think about it in that order. And so, it's maybe a little counterintuitive to people who say, "If you are running an income portfolio, you must just be looking for the highest-yielding things you can find in the market." And that's not true. We always look for great companies that have yield attached so they can deliver hopefully for us, over time, really strong income in terms of the dividend income--the dividends we get from the companies--but also some capital appreciation.

So, the companies don't pay out every single penny that they have as a dividend; we take some of that money as a dividend and we're grateful for that, but we also are curious about what they are going to do with the money we leave behind for them. And they should--if it's a good management team with a good business, a good company, smart people--invest it so that their earnings grow over time, the book value per share grows over time. These things that should, over time, drive the share prices higher as well.

Lallos: You've mentioned looking at payout ratio in addition to dividend yield as a way to signal that.

Hart: People look at the payout ratio and think, "30% payout ratio--that's great to dividends covered." From our perspective, we can do the math on the dividend to see if it is covered or not; but again, with $1.00 of earnings, 30% payout ratio--relatively low--it's $0.30 for the dividend. Again, we're happy about that, but what are you going to do with the $0.70 I left behind? How are you going to make that money work for me? So, your earnings could grow, your dividend should grow over time as well--so, you get more dividends. But also, I think the low payout ratio is really the compromise you have to make in order to make sure the company has money to invest to grow the business and not squeeze every last penny out for the dividend--because you really shouldn't expect your dividend to grow at all. Then, you have the worst-case scenario: something that doesn't grow with a static yield.

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