Fidelity Investments: Valuations, Quality and Dividends Will Drive Stocks

April 16, 2018 — 11:33 AM EDT

With volatility back with a vengeance and concerns mounting that growth stocks are overvalued, Fidelity Investments fund managers are focusing more on choosing stocks that are high quality, properly valued and paying out dividends.

Take valuations for starters. Sean Gavin, portfolio manager for the Fidelity Value Discovery Fund, said in a recent Fidelity Viewpoints blog post that the valuations on equities are "quite stretched," with investors in essence borrowing from future performance to give them the hefty valuations of today. That, said Gavin, will make the high returns seen in the past few years unlikely in the future. To cushion the blow, the fund manager has been focused on "high-quality stocks" that may not provide huge upside but could produce more predictable returns, something lots of investors are craving in this volatile market.

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"One key feature I look for is companies with a strong 'moat,' or barrier to entry, that can make it difficult for competitors to threaten their business – for instance, a business that operates in a very specific niche or that possesses a strong competitive position," said Gavin. He named Allison Transmission Holdings, Inc. (ALSN) as an example. Not only is it a leader in transmissions for a wide variety of vehicles, but it has recently seen strong growth in the commercial truck market. The fund manager pointed to Apple Inc. (AAPL) as another example of a company with a big moat. Gavin said that, at its current stock price, Apple has a "reasonable valuation" relative to its long-term growth prospects.

When it comes to value stocks, while valuations are elevated, Matthew Friedman, portfolio manager for the Fidelity Value Strategies Fund, said there are still some good, high-quality value stocks to invest in. He's focused on companies that have competitive positions that are strong because they tend to do better in times when volatility is on the rise. The fund manager pointed to Darling Ingredients Inc. (DAR), the agricultural processing company, as one example. Others include The J. M. Smucker Company (SJM), US Foods Holding Corp. (USFD) and CVS Health Corporation (CVS). "I have also added to particular positions in the real estate sector, focusing on building a portfolio of stocks I think can add value, regardless of what happens with the future direction of interest rates," said the fund manager.

As for dividends, John Sheehy, portfolio manager for the Fidelity Equity Dividend Income Fund, said that the high valuations make it a good time to look at the role dividends can have when stocks are declining. According to the fund manager, dividends play an important role in total returns, something that can be ignored when stocks are flying higher as they were over the past nine years. Sheehy pointed to the S&P 500, which has had a cumulative return of 159% during the past 20 years ending in February. The same index jumped 277% when taking into account dividends, he said.