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Why a Winning Dividend Fund Likes Home Depot, Target, and Walmart

Scott Davis didn’t set out to become an investor, much less the senior manager of a successful multibillion-dollar mutual fund focused on reliable and growing dividend stocks.

Following in the footsteps of his father, an academic historian, Davis studied that very subject at American International College in Springfield, Mass. His father had been chairman of the history department there.

After graduating from college in 1977, Davis earned a master’s degree in history at the University of Connecticut—only to discover that full-time college teaching jobs were scarce. “My dad tried to warn me about majoring in history, but I didn’t listen,” recalls Davis, who is very fit at 64, thanks to a fitness regimen that includes completing two triathlons.

His endurance and perseverance paid off very early in his career as well. Unable to find a teaching job, Davis became a stockbroker in 1980. His path has included stops along the way as an equity researcher and eventually a portfolio manager.

The Boston-based $23 billion Columbia Dividend Income fund (ticker: LBSAX), which Davis has helped manage since 2001, took on its current approach at the beginning of 2004 after dividend taxes were lowered under President George W. Bush.

The fund recently had a 15-year annual return of 8.7%, besting 97% of its Morningstar peers. It also places in the top 10% based on one-, three, five-, and 10-year results. Year to date, it has a return of about minus 2.4%, still in the top 10% for its category. Its A-share class has a below-average net expense ratio of 0.96%.

The fund that Davis oversees has evolved considerably as its parent firm underwent different ownership through the years. In 2001, he became manager of the Galaxy Strategic Equity fund, which had less of a dividend focus. Around 2003, Davis was tasked with revamping the fund’s focus to one “that only invests in dividend-paying stocks,” says Davis. “I realized quite quickly that dividends in and of themselves don’t create value,” he adds, pointing to free cash flow as a key pillar for dividends and their growth prospects.

With its equity income focus, the fund, which officially took on its dividend investment philosophy in January 2004, is in Morningstar’s large-cap value category. It became Columbia Dividend Income in 2003 when the fund and others were rebranded.

Top holdings as of June 30; returns as of Aug. 10, *Annualized

Sources: Morningstar and Columbia Threadneedle Investments

Davis was introduced to value investing by a fellow stockbroker some 40 years ago. “Value investing just made inherent sense to me—the idea that markets price, but they don’t value,” he recalls. Davis is part of a triumvirate that oversees the portfolio. The other managers are Mike Barclay, 53, who joined the fund in 2011, and Pete Santoro, 48, who came aboard in 2014.

Barclay, who focuses on financial and technology stocks, describes their approach as a “lower-risk equity strategy with a stream of income that grows over time.”

As of June 30, the fund’s top five positions were
Microsoft
(MSFT),
Johnson & Johnson
(JNJ),
Apple
(AAPL), Merck (MRK), and
Cisco Systems
(CSCO).

“Income matters more than yield,” says Barclay, the product of a blue-collar Cape Cod family who studied political science at Cornell University before getting into the financial world. “We are trying to find stocks of companies that have strong underlying fundamentals, whether it be the cash flows or balance sheets that can ultimately support dividend growth.”

Barclay started his career in the early 1990s in a credit training program at a large Boston bank. He also did loan workouts. “I learned a lot about how people could feel really good when times are good and make really bad decisions and get too overconfident in underwriting and investment decisions,” he says.

Santoro, who majored in history at Amherst College, grew up in New York City as part of a large family. One of his childhood dreams was to be the general manager of the New York Yankees. He didn’t get there, but he did write his senior thesis in college on baseball ownership.

He had a stint after college as a paralegal at Skadden Alps, a huge law firm, but then pivoted to Rockefeller & Co., a family office based in New York, to became a consumer stock analyst. He brought that specialty to his current firm, and keeps close tabs on media companies as well.

Paying a dividend doesn’t necessarily mean a company’s best days are behind it, says Santoro. “We are still looking for share gainers and companies that have the ability to grow throughout any market cycle,” he says.

One of the fund’s holdings is
Home Depot
(HD), which yields 2.2%. The managers look for a yield of at least 1% for a stock to qualify for the fund.

“Right off the bat, [Home Depot] generates a lot of cash, has a very strong balance sheet, and a good management team,” says Santoro. The home-improvement retailer is “kind of immune from the
Amazon
effect,” and is benefiting from consumers putting “a lot of time and effort into their homes,” he adds.

The trio has been able to avoid most of the dividend cuts and suspensions that occurred earlier in the pandemic as companies scrambled to save cash.

For example, retailer
TJX Cos.
(TJX) said in March that it wouldn’t pay a dividend in its first fiscal quarter. The team sold the position in early April, and used the proceeds to add to their holdings in
Target
(TGT) and
Walmart
(WMT). Those companies, which were able to keep their stores open during the pandemic, have continued to pay a dividend.

Other holdings include cyclical stocks such as
Honeywell International
(HON), Parker Hannifin (PH), and
Union Pacific
(UNP). Davis considers defense firms
Northrop Grumman (NOC)
and
Lockheed Martin
(LMT), as more defensive holdings.

Portfolio construction is about striking “a certain balance so we can operate well through a cycle,” says Davis. “We are not trying to make lots of guesses.”

Write to Lawrence C. Strauss at lawrence.strauss@barrons.com

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