The fund often underweights technology stocks because many of them don’t pay dividends, according to co-manager Michael Barclay. Once they do begin paying dividends, however, “they can become some of the best opportunities out there because we often see quick and large percentage increases once they start. But we have to be comfortable with their free cash flow, business model and commitment to paying dividends,” Barclay says.
Fund holding Broadcom became part of the portfolio in December 2016, after the company had been paying dividends for about a year. “Before we initiated the position, we met with senior management to discuss their philosophy about capital allocation and confirm that paying dividends is a priority for them,” Barclay says. The managers were also encouraged by the company’s debt restructuring program that converted bank loans to more predictable bonds.
Barclay also cites Microsoft as a strong holding in the technology sector. Since Satya Nadella took over as CEO in 2014, the technology giant has been focusing on recurring revenues from cloud-based offerings rather than less reliable licensing fees.
High valuations in a company are not necessarily a deterrent to the Columbia managers, as long as they can see a clear path toward further growth. Such is the case with fund holding Philip Morris. Even though the stock is a member of the expensive consumer staples category, co-manager Peter Santoro believes the company’s innovative new smokeless cigarette, called Iqos, has the potential to expand sales dramatically.
Also called HeatSticks in some markets, these products have a look and feel similar to traditional cigarettes. They do not burn and are used in conjunction with a controlled heating device. With this “heat, not burn” technology, the levels of harmful chemicals are significantly lower than those of cigarette smoke, according to the company’s website. “With over a billion smokers globally, the launch in 25 countries is only the tip of the iceberg,” says Santoro. The stock has a generous 3.7% dividend yield.
Home Depot, another stock Santoro likes, has had “exceptional and consistent top-line growth” in the home improvement sector. Other factors supporting the stock include the strong underlying growth in the home improvement sector, low mortgage rates supporting the housing industry, and a business that is difficult to replicate. “These factors provide a big runway for Home Depot over the next few years,” he says.
With a turnover ratio of 25%, about half that of the Columbia fund’s Morningstar peers, it’s clear the fund is faithful to its picks. But Davis and his team aren’t afraid to weed out a stock when free cash flow falls into the bottom two quintiles for that metric and prospects for improvement within a year or so are murky. They did that late last year with longtime holding General Electric as its deteriorating cash flows hit the company and the firm’s analysts struggled to find a way the company could reverse the trend.
The stock’s removal reflects a philosophy that has helped keep the fund out of trouble when dividend cuts hit the scene. “A lot of dividend strategies focus first on yield,” says Barclay. “We think it’s more important to look at how well a company is prepared to sustain and grow its dividend over time.”