Cheap Dividend Payers and Short-Term Bond Funds
Sustainability in fixed income, saving differences by gender, and a bargain in CenturyLink.
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Our quarterly series, Ultimate Stock-Pickers, culls investment ideas from the most recent transactions of some of our favorite investment managers. While the vast majority of our Ultimate Stock-Pickers are not dividend investors, a handful of them focus more heavily on income-producing stocks in their pursuit of investment return. To get to a list of buy ideas, we've screened for stocks with a wide or narrow economic moat and an uncertainty rating of low or medium.
One of the stocks that passes the test and is also undervalued according to our measures includes cigarette maker Philip Morris. This stock is currently trading at almost a 30% discount to our fair value estimate of $102, which implies a forward 2020 multiple of 18 times earnings per share and a dividend yield of 5%. Philip Morris has received a lot of negative press recently after announcing that it is in talks to merge back with Altria (which had completely spun off its international tobacco operations during 2008). We think that this potential deal makes a lot of strategic sense.
In addition, two large drug manufacturers, Pfizer and Gilead Sciences, make the list. Wide-moat Pfizer is rated 5 stars and carries a low uncertainty rating. We think that economies of scale, patents, and a powerful distribution network should allow the company to earn an economic profit for years to come. Gilead Sciences has also carved out a wide economic moat and trades in 4-star range with a medium uncertainty rating. Patent protection on Gilead's newer HIV regimens and continued dominance in the hepatitis C market will be enough to ensure strong returns for the next couple of decades.
We think long-term investors should consider these names.
Christine Benz: Hi, I'm Christine Benz from Morningstar.com. How far behind are women relative to men, when it comes to retirement savings? Joining me to share some research on that topic is Judith Ward. She is a senior financial planner for T. Rowe Price.
Judy, thank you so much for being here.
Judith Ward: Thanks.
Benz: Judy, you did a survey of people, women, at various life stages attempting to get your arms around how they approach retirement savings, how they're doing toward retirement preparedness. I think the general takeaway is that women are lagging their male counterparts, but you did examine it by generation. Let's start with the baby boomers, because these are people who are entering retirement, in retirement. How are they doing in terms of retirement preparedness?
Ward: So, at T. Rowe Price, we have a retirement saving and spending survey that we do on an annual basis. And we cut that by gender, and also, somewhat by generations. And yeah, it validates a lot of the research that we've seen out there that women are lagging in terms of income, and they're lagging in terms of retirement savings.
Benz: So, the income differential largely explains the savings shortfall.
Ward: Yes, absolutely. The baby boomer women were the worst off. And honestly, that wasn't unexpected, because when you think about--I'm a baby boomer--so, when you think about along our careers, most of us have maybe taken time out of the workforce. I know a lot of my friends who are stay-at-home moms. Maybe we've altered our careers for caregiving, or when we've had children. So, we just didn't concentrate as much on the career. So, that's really not unexpected.
But what I would say is moving into retirement, what women need to be cautious of is the idea of how the household is going to hold up while they're in retirement. Another thing we found in this research was that if the retirees who had been retired for 11 or more years, 45% of the women were divorced or widowed, versus just 17% of men. So, that means at some point, because statistically women outlive men, that they might be going solo. And so, it's really important to be engaged with the finances and understand what's going to happen when one of us is a surviving spouse, and am I going to be OK.
Benz: And I've always heard that the single retired women, that's one of the most at-risk cohorts, right?
Ward: Right. Yes. Yeah, and there's some things that you can do. Of course, you can understand "What is going to happen with our assets?" if you haven't been involved in that aspect. Get involved. Again, you don't have to be an investment guru, but you have to understand what's going to happen. Another thing prior to retirement is the Social Security decisions. Those are really important, especially if you want to maximize the benefit for a surviving spouse. So, those are some pretty heavy areas that can really make a difference for women in retirement.
Benz: And, I guess, "get help" would be another piece of advice.
Ward: Yes. Absolutely.
Benz: OK. So, you say when you look at these surveys, the boomer data discouraging, but not surprising. One thing that jumped out at you that you thought was a little more surprising was what's going on with millennial women. So, let's talk about that, that here again you see some of the same patterns, lower incomes relative to men, as well as lower retirement savings.
Ward: Right. And that was a bit concerning, because I spend a lot of time trying to educate people about retirement savings and financial wellness. And so, it was really discouraging to see that millennial women were lagging in terms of their income and retirement savings compared to their male counterparts, consider they are the largest generation in the workforce now. And some of it has to do, I think, with their job choice. They may be going into jobs that do pay a decent wage but might have limited upside potential.
Benz: What would be an example?
Ward: Well, so an example--we saw the social services industry as--I think the women were in that industry 3 to 1 compared to men. The information technology industry, for example, the men were like 2 or 3 to 1, to women. And so, some of those industries, they have a pretty good starting salary, but they also have a lot of upside potential. So, that…
Benz: In the IT space.
Ward: Yeah, in the IT space, or some of these other industries. And I'm not going to pass judgment on why people choose the career that they want. But I think it just means that women need to be intentional about their saving and their spending, and to make sure that they get on a good track to manage the financial aspects.
One interesting thing we found was that their levels of debt were about the same. I mean, there wasn't--like their student loan debt didn't jump out as being different than their male counterparts. But when they have a lower income, that debt-to-income ratio is higher. So, try to manage debt. We talk about budgeting. That's a framework to help you understand where you're spending your money and incorporating savings goals. The money on the side--I think it's important for women to have some flexibility, so they maybe could change careers if they choose to. So, I think there are some very tactical things that not just women, but anyone really saving for retirement. But you have to be mindful and intentional to put those things into action in order to just set yourself up for a good retirement and a good financial independence really.
Benz: Did you aim to get your arms around how confident or comfortable women are relative to men when it comes to financial decision-making?
Ward: We didn't ask that specifically. But I do recall a question we asked about: "Do you know how much you should be saving for retirement?" More women than men said they do not know. Or they answered, you know, very low amount.
Benz: I saw that on the survey, like, 3%, 4% in some cases.
Ward: Right. And so, that tells us there's an opportunity to really reach out to women and make sure they understand what are some good rules of thumb. It's an educational opportunity. And that they are they're willing, they want advice, they want people to help them. But they need advice that fits into their busy lives and is available when they need it. But they're willing. So, I think just the fact that they're saying, "I don't know," they're telling us that they want the education and they're asking for it.
Benz: Really interesting research, Judy. Thank you so much for being here.
Ward: Thank you.
Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.
Matthew Dolgin: After doing a deeper dive into CenturyLink recently, we feel even more strongly that the market is mispricing its stock.
Accelerating sales declines, a large debt load, and fears about another dividend cut may be behind the dismal stock performance over the last year, but those concerns are overblown in our view.
We project sales declines to continue throughout the next five years, driven by technological advances and price deflation for firms running legacy telecom networks, but the more important thing is that CenturyLink has continued growing profits and generating significant free cash flow despite those headwinds. We think the firm can continue expanding profit margins and generating about $3 billion in free cash in each of the next five years.
With that $3 billion, we expect CenturyLink to maintain the current dividend, which requires only about $1 billion, and to continue paying down debt with most of the rest. Consequently, we believe the firm is in good position to meet all its debt obligations, and we don't think it will have to roll over maturing debt until at least 2022.
Although we don’t think CenturyLink is protected by a moat, it does own a first-rate global network that the biggest organizations in the world rely on. That network distinguishes CenturyLink from its regional consumer telecom peers that have run into financial difficulties recently. With 75% of its revenue coming from business customers, a network that is critical for global communications, a path to sustain $3 billion in free cash flow annually, and constant improvement in its debt position, CenturyLink should be trading at higher than 4 times free cash flow, and investors can receive an 8% dividend while the market figures that out.
Christine Benz: Hi, I'm Christine Benz for Morningstar. As markets have turned volatile, many investors have looked to shore up the safe portions of their portfolios. Joining me to share some favorite short-term bond fund picks is Russ Kinnel. He's Morningstar's director of manager research.
Russ, thank you so much for being here.
Russ Kinnel: Glad to be here.
Benz: Russ, let's just start by talking about the role that short-term bonds or short-term bond funds might play in a portfolio. How would I use them? And how would I think about right-sizing that position?
Kinnel: I think short-term bond funds are very useful, even if unexciting, because they can take that step as the next line of defense after your money market fund. They're going to have a little more yield and a little more return. But also a little downside, a good short-term fund with high credit might lose 30 or 40 basis points in a down year, at least that's the history. So, there's a bit of a risk involved, but not a lot and a little more upside. So, I think it's a really useful thing. You can use it as your next line of defense. If you have say, some upcoming expenses--you're going to buy a car, you've got kids' tuition bills, anything like that--I think it's a really good place to invest. So, I think it's a pretty useful tool for just about any portfolio.
Benz: You definitely don't want to think of short-term bonds, though as kind of a tactical parking place. If you are worried about equity market volatility, you shouldn't be flipping things around based on short-term market action, right?
Kinnel: No, please don't do that. So, market-timing is a very hard thing to do, and I wouldn't recommend that.
Benz: So, let's get into some of the funds that you really like in the short-term space. Let's start with a very safe, short-term fund. Vanguard Short-Term Federal. I'm guessing low costs would be part of the appeal here.
Kinnel: Yes, low costs, almost no risk. So very--it's the next step out for money market in terms of duration. It's all as the name implies, it's all federal government, mostly mortgages and Treasuries, so, high quality. It'll get you a little more yield than a money market. But again, that’s just very much at the most conservative end, if that's what you really need.
Benz: Let's take a look at a broader short-term bond fund. This is Fidelity Short-Term Bond. Let's talk about it, and its overall complexion takes a little bit more credit risk, but generally a pretty guarded profile here, too.
Kinnel: That's right. So, besides mortgages and Treasuries, now you've also got a lot of high-quality investment-grade corporate bonds. So, now you still have almost all the assets are in AA and AAA. But again, with corporate debt, you've got some more risks. This is a fund that had some issues in '07 and early '08, and they kind of got religion about really being more disciplined about staying dedicated to high quality, and they've been a very steady fund ever since.
Benz: So it's been a pretty risk-conscious option. How about for investors who are looking for a little bit of inflation protection along with their short-term fund? One fund that you and the team like is Vanguard Short-Term Inflation Protected Index. Let's talk about that.
Kinnel: This is a really great fund, we rate it Gold, super cheap. But as you mentioned, it's a nice inflation protector, because TIPS give you inflation protection, but because it's short-term, it also doesn't give you that interest-rate risk that regular TIPS funds do have. So, you're even less risky than a regular TIPS fund. Footnote on that is, TIPS funds really mostly belong in a tax-sheltered account because of the way the taxes are figured for TIPS funds. So probably a good fund for like retirees, IRA, or something like that, where if you're fairly bond-heavy portfolio, you might want a little more inflation protection.
Benz: Great point, Russ. Speaking of taxes for investors, taxable accounts, you have another idea that's T. Rowe Price Tax Free Short Intermediate. This is a municipal bond fund. So, let's talk about, first, who should look at municipal bonds, and then get into the specific attractions of this fund.
Kinnel: Sure. Obviously, people with higher--in the higher tax brackets--are most likely to benefit from muni funds. It's worth running your own situation through one of the muni calculators that are out there. But if it works for you, and I think munis also provide a little nice diversification, munis are very rare to default. So, a fund like this, I think is a really nice diversifier. It's short intermediate, so it's got a little more interest-rate risk. It's got a little more credit risk, and then it's got some meaningful exposure to AAA, B, and A, but we really like T. Rowe; we think they've done a great job here. We did downgrade the fund from Gold to Silver, not because of concerns about management or strategy, but just because fees have remained kind of high while others have gotten cheaper. So, it's kind of only an average fee. But otherwise, we really like the fund. I think it's a really nice way to get some muni exposure without a lot of risk.
Benz: Russ always great to get your perspective. I know our viewers love to hear your picks. Thank you so much for being here.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.
Jon Hale: Hi, I'm Jon Hale, head of sustainable investing research at Morningstar. With me today is Karin Anderson, a director of manager research and an expert on fixed-income strategies.
Karin, thank you for joining me.
Karin Anderson: Thanks very much, Jon.
Hale: Karin, you and your colleagues recently published a report on sustainable fixed-income funds. Can you start us off by just telling us a little bit about the main takeaways that you had from that report?
Anderson: Yeah, of course. We were very interested to take a closer look at this space because it's clearly been changing quite a bit in the past few years. There aren't as many sustainable fixed-income funds out there compared to in the equity space. But there's certainly been a lot of development recently. We've heard a lot of larger asset managers are trying to step up their ESG capabilities, some of them making some pretty clear commitments to sustainable fixed-income offerings in the next few years. So, we decided to speak with many of them. I think we did about 12 conversations with these companies to find out exactly how they were going about this.
Hale: You noted a range of approaches in the paper to ESG investing taken by various asset managers. Can you outline some of those for us?
Anderson: Sure. We identified three clear strategies in this space. So, those are ESG Consideration, ESG Focus, and Impact Investing. So, the first one, ESG Consideration, is sort of the lightest form of this. Essentially, ESG data is available to portfolio managers who use it as they will. So, this information doesn't necessarily make or break every investment decision, but they have it at their disposal. The second form is ESG Focus. So, this is a higher commitment to ESG investing. So, typically, we see ESG factors having an impact on security selection, on up to overall portfolio construction. So, of course, this is a much purer form of ESG investing. There are many styles that fall under that umbrella. It was quite interesting to learn about all those. But a lot of them tend to focus on best-in-class companies or securities or even countries to form up the overall portfolio. The third type is Impact Investing. So, a lot of people have heard of green bonds these days. Those types of funds typically focus on those to a fair extent, but they may also have some sort of a social goal. In the end, Impact Investing funds are trying to deliver some sort of social or environmental goal alongside a financial return.
Hale: Right. And so, the three, sort of, shake out as like: Consideration--a little bit of a lighter approach, as you said--with a more comprehensive approach towards the Impact side of things.
Hale: Interesting. So, you've been in this space a long time, as far as fixed income is concerned. As you were talking to all these asset managers about ESG, was there anything that jumped out at you that was surprising to you?
Anderson: Sure. These conversations were very interesting in that many firms are really building up their ESG teams right now. I think everybody wants to be able to offer any of these types of strategies that I outlined. But I think maybe the surprising part is just how long the road to standardization will probably be in this space. For one, there are so many inputs that asset managers are using--a variety of third-party data providers. Some are taking that information at face value; some will manipulate it further. Firms are developing quantitative and qualitative frameworks to try to make sense of all this information and then maybe putting their own overlays on this. So, as far as being able to make apples-to-apples comparisons just among this group of sustainable fixed-income funds, that actually seems pretty hard at this point. So, that's why I think we're at Morningstar committed to measuring these funds and evaluating these funds against conventional peers for the time being.
Hale: Well, and certainly, the paper gives folks kind of a primer on what's going on among various asset managers in this area. Karin, thanks so much for being with us today.
Anderson: Thank you.
Hale: For Morningstar, I'm Jon Hale.