This bear market is very difficult to invest in because there is no reliable precedent for it. John Linehan of T. Rowe Price shared how he manages over $16 billion in assets. Here’s how Linehan finds dividend stocks for steady income as the economy weakens.
John Linehan, the chief investment officer for equities at T. Rowe Price, has encountered plenty of different investing landscapes in his 33-year career. But he’s never seen a market like this one.
Every bull and bear market is unique, Linehan told Insider in a recent interview. And while there are similarities between them all, he believes it’s a mistake to assume that what worked in past downturns will work today.
“No two bear markets are alike,” Linehan said. “No two recessions are alike.”
Linehan continued: “There’s no rhyme or reason to any of them. And to try and employ a playbook from the past doesn’t necessarily make sense going into the future.”
Investors today are rightly focused on the economic risks stemming from the Federal Reserve’s decision to quickly raise interest rates as a means of slowing stubbornly persistent inflation, Linehan said. The near-unanimous consensus among CEOs in a recent survey is that this will cause a recession as tighter monetary conditions force consumers to cut back on spending.
Linehan, who manages over $16 billion in assets in the T. Rowe Price Equity Income Fund (PRFDX), is currently attempting to thread the needle between playing offense and defense.
“I want to be really thoughtful about the risk we’re taking in the portfolio in this environment,” Linehan said. “I don’t want to get over my skis in terms of having too little risk, and I don’t want to get over my skis in terms of having too much risk.”
When the market does rebound it will do so quickly, Linehan said. But at the same time, he said it’s wise to prepare for far more downside risk if the Fed is forced to keep hiking rates.
“What I’m trying to do is construct a portfolio that hopefully can survive the test of either extreme,” Linehan said. “And as a result, we’ve tried to have part of our portfolio be fairly defensive and part of it be offensive and really look more for idiosyncratic names that we think will do well over time.”
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Unlike some portfolio managers, Linehan said he has a hefty chunk of his net worth in his fund.
“I invest in the money like it’s mine because, in a lot of ways, it is,” Linehan said.
As if that’s not enough pressure, Linehan is responsible for managing the retirement money and savings of countless other people. That gives him a “healthy appreciation for risk,” he said, but he can’t allow himself to be paralyzed by the risk of losing some of the $16 billion he oversees.
“In terms of the amount of money that we manage, I think if you get focused on that, it can be overwhelming,” Linehan said. “So rather, I just try and focus on creating the best portfolio — the optimal portfolio. Regardless of whether it’s $100 million or $100 billion, I don’t think it should change.”
Although the T. Rowe Price Equity Income Fund is down over 10% this year, it has beaten its index (which is down 13.7%) and is in the top 30% of funds in 2022, according to Morningstar.
When it comes to finding the right stocks for his income-focused fund, Linehan said he looks for US and global companies with attractive valuations and positive fundamentals that will provide solid dividend yields and perform well over a long time horizon.
Key valuation metrics to consider are a firm’s price-to-earnings (P/E), enterprise value (EV) to sales, and price-to-book (P/B) ratios, as well as industry-specific measures, Linehan said . These metrics go hand in hand with a firm’s trajectory and the story it is able to tell about its business, he added.
But a great company isn’t always a great stock if it’s overvalued, the portfolio manager said, and conversely, cheaply valued stocks are sometimes discounted for good reason.
High, reliable dividend yields are vital to the T. Rowe Price Equity Income Fund, Linehan said, but the size of the quarterly payment is far from his only consideration on that front. Yields reflect a firm’s financial health, ability to generate free cash flow, and capital discipline, he said.
“We’re looking for companies that have both an attractive yield but also attractive attributes beyond the yield,” Linehan said. “Just finding companies with the highest yield, I think, in the long run is a difficult environment to be in because you really have to question on each investment the durability of that yield.”
Finally, Linehan keeps a long-term view on his investments, which he said is easy to say but hard to do. His fund has about a 20% turnover rate, which means that he holds a stock for an average of five years. Markets can swing wildly between quarters, but in the long run, a company’s valuation, fundamentals, and yield are what will cause it to either sink or swim, he said.
“So many people are focused on the short term and whether a company’s going to hit or miss earnings for the next quarter that they get so caught up in the trees, they lose sight of the forest,” Linehan said. “One of the things I want to make sure is that — I can’t tell you necessarily what a company is going to do in the next quarter, but I can tell you whether we think they have an attractive fundamental backdrop over the next several years.”
That mindset means that Linehan is patient with his holdings, especially during rocky markets. Unless a stock’s thesis deteriorates to the point where it’s no longer true, Linehan said he’s inclined to hold them — even with unprecedented and unpredictable risks on the horizon.
“We don’t pull the plug just because the company’s underperformed,” Linehan said. “We’re going to be patient. And a lot of times, that patience is rewarded.”