Domestic Equities - Focusing on Large Companies

By Jonathon Coleman - Co-Chief Investment Officer, Janus

Certain financial news shows tell you what to freak out about in the next five minutes. But I think investors need to think about the next five years. Right now, I believe that the broad backdrop for equities is favorable, particularly relative to other asset classes. We have recently seen dividend yields on stocks that are roughly equivalent to intermediate-term corporate bonds. That seems to be a rare mismatch, which I think heavily favors equities. Stocks can provide not only a return of capital, in the form of a dividend, but you get the potential of a rise in the stock price as well.

I also believe that U.S. large- and mega-cap equities are uniquely attractive right now. In my estimation, they have been trading at one of the widest disparities to small caps that I have seen in the last 25 years. They’re able to benefit from global growth because they typically generate between 25% to 50% of earnings outside the United States, including meaningful exposure to emerging markets. Plus, corporate balance sheets look rock solid, with a little over a trillion dollars of cash. In fact, one could make the argument that corporate balance sheets are the strongest they’ve ever been.

The simple truth is, we have an incredibly dynamic economy in America. The last decade has been a difficult environment, but companies have become lean and mean. We have operating margins at all-time highs relative to where we are in the economic cycle. U.S. companies have also become more productive, which is one of the reasons that unemployment is frustratingly slow to improve. We’d all like to see unemployment significantly lower, but the high level of productivity is one of the reasons domestic companies are doing well and equities are so attractive.

Inflation is certainly a risk, but equities can do well in a moderate inflation scenario. In fact, history will tell you that equities have done well in periods when inflation is picking up, but isn’t running out of control. With this in mind, I focus on companies that I believe have the power to raise prices and protect margins when inflation-driven costs go up.

I believe in the value of content from media companies. As recently as a year ago, there was a prevalent belief that the fragmentation of audience via the Internet was really going to be a challenge to owners of content. But we’ve seen just the opposite. People are spending more time with valued content. This year’s Super Bowl, for example, broke the viewership record set by the final M.A.S.H. episode, way back in 1983.

We’re also interested in how cost containment within health care will play out. The fund I co-manage has owned a number of generic pharmaceutical manufacturers, as well as pharmacy benefit managers that may benefit from the pressure to lower costs. We have also found some interesting opportunities in big pharma, at least among companies willing to cut costs meaningfully.

And we’re looking at companies that have a steady history of increasing dividends over time. If you look over the long term, dividends account for 50% or more of the total return. When companies pay a dividend and increase it steadily, they’re saying, “Hey, we have confidence in the future of our business.” And that’s usually well founded because company managers often see things that individual investors just can’t foresee.