The Active Investor: For Equities, a Focus on Quality in a Volatile Market

Brian Foerster: This is Brian Foerster. And welcome to The Active Investor podcast, our monthly look at what's happening across asset management, and how investment leaders at our firm are thinking about markets and opportunities today, as well as strategies that can help investors navigate different challenges.

We took a bit of a hiatus on this podcast series with the move we had at our firm into a new building -- here now at 30 Hudson St. [Jersey City, NJ] -- and the buildout of our new podcast studio. And so we're back, and ready to resume. And in today's edition, we welcome back Darnell Azeez, to talk about equities, and specifically high-quality equities.

Darnell is the head of our value equities capability at Lord Abbett, which has two distinct approaches: one that is focused on dividends, and one focused on more traditional or value-style box strategies.

He's a partner at our firm and has been with Lord Abbett for the better part of two decades. So, Darnell, welcome.

Darnell Azeez: Thank you, Brian.

Foerster: So, as we're recording this, I should note that it's April 9, 2025. And so, we are in the midst of a sudden almost bear market. And it's one that's been sparked by a big fiscal shock, namely tariffs and trade wars. And so, as a result, equities have seen some sharp declines, big swings up and down over the past couple of weeks, particularly in the past seven days since the tariffs were announced.

And a lot of people are starting to worry about things like a recession, even more volatility, and overall repricing of risk, and earnings, and economic growth. Before we get into all that fun stuff, though, one thing we didn't get into last time that we talked on this podcast was just a little bit about your background. So maybe you could talk about how you got into investing in the first place, and then how you ended up being a value investor here at Lord Abbett.

Azeez: Sure. Happy to do that. Thank you, Brian. And hello everybody. So, I had a little bit of a nontraditional route into my current role. First, I probably don't have the typical Wall Street background. I was an inner-city kid, grew up in the Bronx and played football in college, went to Lafayette. And then started my career here at Lord Abbett over 20 years ago on the sales desk, actually, in a distribution role. So I started in sales. Did that for two years. Then I moved into institutional sales, selling our products to pension funds, Taft Hartley [retirement plans], et cetera.

And in those two years, I worked through the CFA [chartered financial analyst] curriculum, passing levels one and level two. I didn't have a grand scheme to become an investor. It was simply I wanted to be a more differentiated salesperson. I was younger than a lot of my peers and figured I would relate to clients from a more technical standpoint.

But when I passed the first two levels, I thought maybe I'd try to pivot into an investment role, thinking, "If it doesn't work out in investments, I can get back into distribution." Whereas if I went too many years into distribution, it would be difficult to reverse into investments.

Additionally, I just always had a large interest in learning a lot of things, and a pretty curious mind in general. And I really had an opportunity to push further into that aspect of myself in investment. So got the opportunity in late 2006, early 2007 to work as a member of our value team at that point.

I was a small cap [equity] analyst, a small cap generalist, so I looked at smaller companies across industries. Got a really good technical learning -- how to understand businesses, balance sheets, income statements, and really sort of the nitty-gritty analytical work that any person that gets into investment would go through.

I did that for a number of years. I actually left the firm for about a year and a half--came back and rejoined the firm as a fixed income portfolio manager, working as a PM [portfolio manager] on our multi-asset strategy Bond Debenture strategy as well as a PM on our convertible strategy for a few years.

And then I was asked to come back to the equity department to work as a portfolio manager leading our income strategies--Affiliated and Dividend Growth, and then eventually to head up our entire value franchise, as you mentioned earlier, Brian. So, I've had a lot of diverse experience in sectors, as well as asset classes.

And I think that's sort of well-rounded me out in terms of being an investor, a value investor. I think ultimately everybody's a value investor. Ultimately, everybody wants to own quality companies at attractive valuations. And how you go about that may vary. But ultimately that's what any investor's trying to do, right? You're trying to provide good risk-adjusted returns, buy good businesses at attractive prices.

Foerster: Yeah. That's interesting. I mean, you don't hear a lot of equity PMs that at one point were fixed income PMs. That has to give you kind of a unique perspective on the capital markets.

Azeez: Absolutely. I think just understanding how different investors see the world, understanding how people think about risk, in particular, right, fixed income managers are very concerned about getting paid back. Equity managers a lot of times are thinking about the optimistic scenario in terms of upside, things like that, and trying to triangulate those views to understanding both markets and individual investments is very, very important. And ultimately, you're just trying to see things a little bit differently than maybe the consensus [view] of the market to drive outperformance. And so, I do lean into all those relationships and that experience that I've had throughout my career.

Foerster: Interesting. Well, I would imagine that's give you some assistance right now, but maybe not. We're in the midst of some market chaos right now. And maybe we kind of go there. And I'll just reiterate that we're recording this on April 9. We're going to try and make some sense out of it, but this might get outdated in a couple of hours or a couple of days.

But I would like to get your sense of how you're thinking about this very new environment that we've entered over the past week really, particularly with tariffs, trade wars, the fears of triggering a recession. How are you and your team feeling about equities right now, along with the broader earnings and economic environment, given everything that's going on?

Azeez: Sure. Yeah. I mean, as you mentioned, it changes by the day, by the hour, and by the minute almost. And we're adjusting our views accordingly. I think the best thing to do is maybe take a step back and think about sort of the path and how we got here. So obviously the market priced in a lot of positivity post-election.

I think there were a few reasons for that. Obviously, there was concern that the election would be disputed. It certainly wasn't. It was a resounding victory. And then there was the assumption that it was a very, very pro-business administration that was coming in.

I think a bunch of people were quoted as saying this is the most pro-business government that we have seen in our lifetime. And you saw risk assets respond to that. So markets were very buoyant post-election. So, you had a lot of positivity and optimism built into the equity markets.

You've seen positioning that was very, very extreme. Sentiment was very, very positive and extreme coming into this year. And what I thought happened in 1Q [the first quarter of 2025] was a little bit of unwinding of some of those extremes. And a lot of that really was focused on sort of the big Mag 7 [Magnificent Seven] names.

And so 1Q, though the market was down around 5%, the equal-weighted S&P [500 Index] was essentially flat. So, I felt like that was more of a positioning unwind as opposed to people more concerned about recession. Oil was a top-performing sector in 1Q. And you don't tend to see energy stocks outperforming when people are worried about a recession.

Foerster: Right.

Azeez: But it was under-owned. And I think it was more of a positioning unwind. So, if you fast forward to post-“Liberation Day” [the April 2 tariff announcement], I think things have changed rather dramatically. And what you've seen now is sort of the reverse where I think now the market and many strategists are pricing in recession odds much higher than it had been previously.

So what we've seen is now, very importantly, spreads starting to widen out on the fixed income side. You start to see more economically sensitive areas, banks, energy, and oil prices begin to drop pretty rapidly. You see tremendous volatility in the equity market.

More economically sensitive areas begin to drop as the market is really grappling with the uncertainty that's coming out of the administration in the global sort of tit-for-tat that we're seeing right now. Markets don't like uncertainty.

And we're trying to navigate it through like everybody else. I think ultimately what we're trying to do is find high-quality companies trading at attractive valuations. That tends to be our strategy in all environments. I think this is a great opportunity to maybe upgrade our portfolios.

When we sit down as a team, we think about companies that we have a watch list obviously of names that we look at. And we say, "Well, if we were worried about valuation for X, Y, and Z, now is an opportunity to do that." It's an opportunity to upgrade your portfolio.

We have to, as investors, take a six- to nine-[month], one year outlook on things. And in fact, we underwrite our investments over a three-year time period. So I think that's what we're trying to do. I think that's what most people are trying to do, if you're paying attention.

Take advantage of the volatility, lean into it, and come out on the other side in a better situation than you came in on. The other thing, you can take a step back and just look at historically when you have these jumps in the VIX [CBOE Volatility Index] over 40 and over 50, the forward returns in equity markets are quite attractive.

Foerster: Right.

Azeez: And this is not my first crisis. This is not the team's first crisis. I started right at the beginning of the [2008–09] financial crisis. We've dealt with COVID obviously. We were talking earlier. People forget about SIVB [the failure of Silicon Valley Bank in March 2023], the banking crisis, the Yen carry trade [market disruption] last year. I mean, this is a little bit different. But at the end of the day, our job is to navigate through this and take advantage of the volatility.

Foerster: Yeah. And also, we're having a once-in-a-century crisis every two years.

Azeez: It does seem that way.

Foerster: All right. Thanks for that. I mean, it's a fluid situation, and a lot to pay attention to. You mentioned the word high-quality. So, thinking about the importance of things like profitability, return on capital, free cash flow, strong balance sheets, growing dividends, all signals of quality.

And it seems like that word, quality, has become really important, since the inflation surge of '22 and '23, not that it wasn't important before then. But certainly, with the normalization of rates, it's a very different world than, say, the post-GFC [global financial crisis of 2008–09] environment of zero interest rates when quality didn't seem to be as important. Can you talk a little bit about just the overall evolution of value investing in the last few decades and sort of where that quality component fits in?

Azeez: Happy to chat about it. I think it's an important question, and particularly right now. We went through that period of “free money” [interest rates near zero] post-GFC up through COVID, and then we got hit with an inflationary scare, and then obviously the Fed [U.S. Federal Reserve] responded by raising rates.

To sort of answer your question, I don't think we're going back to this free money era anytime soon. If you look at the [U.S. budget] deficit, if you look at tariffs which are inflationary, as we have this conversation right now, I think the scariest part is that rates are going higher with equity markets going lower.

I don't know if that'll last. But that's certain the scenario we're in right now. I think the Federal Reserve will probably react with interest rate cuts. But I don't think that the aggressive liquidity injections are coming back. So, what does that ultimately mean?

If you think in a world where money is no longer free, the market is going to be more discriminating in terms of what it rewards. And so, the market's going to be more discriminating in terms of coalescing around quality names. It's not good enough to have a great idea that's going to make money sometime in the future.

When risk-free assets were zero, that was okay. That was an option. But right now, that's no longer the case. So, we think that's important--we focus on quality. We want companies that can navigate an uncertain environment. We want companies that can self-fund. We want companies with strong balance sheets.

We want companies that can thrive, take market share in a volatile environment. And kind of going to your question about the evolution of value investing, I'll tie it back to that. From a valuation standpoint, we look at normalized free cash flow yield as our main valuation metric.

In a world that has evolved to focus on more intangible assets as opposed to tangible assets in the modern economy, the idea of looking at price-to-book value companies in a modern economy, I think you miss a lot. And value investors that haven't made that adjustment to look at free cash flow, and are still looking at book value, you're basically running a valuation analysis for an economy that was in the 1960s and 1970s.

It's ironic, because a lot of what the U.S. is doing from a tariffs standpoint is trying to bring back those old manufacturing jobs, which are gone. But we like companies that generate a ton of free cash flow. We normalize the free cash flow over a three-year time period.

And we focus a lot on quality. So, the combination of quality, valuation, and stability allows us to self-select a portfolio of good companies trading at attractive valuations. And the right valuation metric we think is normalized free cash flow yield.

Foerster: Yeah. Because, I mean, book value has lost a lot of its value, right? Because it only captures tangible assets, so plant, property, and equipment. So, like you were saying, back in the '60s, and '70s, it made probably a lot more sense to look at price-to-book than today, when we're in a very asset-light economy.

A lot of assets are no longer captured in book value. It's intangibles. So, I mean, you're really putting a big priority on free cash flow yield versus say price to earnings, price to book. That whole normalization component, kind of maybe walk us through how you think about just that valuation metric, and how that helped you identify great companies at good prices.

Azeez: Absolutely. We normalize the free cash flow estimate based on--markets run in cycles. And so you can have ups and downs. And so, we think when you look out and normalize free cash flow yield, you avoid buying companies at cyclical tops. And you can lean into companies at cyclical bottoms, right? You avoid value traps is essentially what we're trying to do, which is something that has destroyed value managers since there have been value managers around. A lot of people may ask, "Why not pay attention to earnings?"

And we do pay attention to earnings, just the same way we pay attention to book value when it comes to certain financials, et cetera, where it's relevant. But the problem with earnings is earnings can be manipulated by accounting gimmicks.

Ultimately, it's very, very difficult or impossible to manipulate cash flow, unless you're really, really trying. So that really gives you a better underlying view of what the underlying business is doing and producing. And so, we lean into that quite a bit.

Foerster: Okay. Now, let's shift gears a little bit here and talk a little bit about dividend investing, which I know your team manages two strategies focused on dividends. One is focused in particular on the growth of dividends, really companies that can consistently grow them, even during the worst of times.

So, what's interesting here is companies like that, that can grow year after year their dividend, you would argue that they probably have to be sort of high-quality companies to be able to do that. They also don't tend to be the highest yielding ones, though, right?

And so, it's not necessarily a strategy where you're clipping a coupon and almost replacing fixed income, but it's more like a signal of quality, I think. Maybe you could just talk a little bit about just sort of how you think about a strategy like that, and sort of what value that serves for investors, especially at a time like this.

Azeez: Yeah. This is absolutely a great time for, we think, dividend growth investing in general. So, I'll take a step back and just talk about the genesis of the product. Ultimately what we noticed was that companies that have increased their dividends for a number of years provide what I mentioned earlier, what everyone's looking for from the investment standpoint, which is great risk-adjusted returns, so better returns, less volatility, which is ultimately what you want in any investment.

So, we built a product around that--dividend growers. And so essentially what we're doing is fishing in a higher quality pool, to your point, Brian. Companies, usually we tend to look at it around 10 years of dividend growth history. We have a lot of flexibility around that. But if you've been able to grow your dividend for a number of years, it probably indicates that, one, you've gone through a few market cycles, two, you have a strong enough balance sheet to give your investors a raise year after year.

Three, you probably have a management team and a board of directors that understand that returning money to shareholders is very important. So, what does that do? It probably prevents them from making humongous bets that may hurt the financial position of the company.

And to your point about high yielders, we like current yield as much as anybody else, but you tend to have two flavors of high current dividend yield stocks. One, you have sort of your low beta high yielding names, which you may get in pharma or telecom. Nothing wrong with those names. We own a few of those. We like good, fundamental companies, and good fundamental stories.

But yield's important, just like valuation is. But ultimately if a stock's just going to go sideways and give you a big chunky yield, that's okay. But you can also just go in cash, and get no volatility, and get the same amount of yield.

The other thing, which is much, much worse is that, again, people forget that yield moves inverse to price. So, if a company has kept their dividend flat, and the stock keeps dropping, and dropping, and dropping, the yield will go up. Yeah. So, it's great if you've got a 9% dividend yield. But if that 9% yield is the market telling the company they need to cut the dividend, as good as the dividend grower risk-adjusted returns is, dividend cutters are the absolute worst. So, we want to avoid companies that are potentially at risk of cutting their dividend, because that's not a good situation to be in.

Additionally, what I would say is that, again, there's a difference between yield and income. We focus a lot when we try to explain to our clients, the focus there should really be yield on cost, right? So, yeah. Okay. So, you buy a $100 stock. It's got $1 dividend. Maybe that $1 dividend is a 1% yield. So you may not feel great about that.

But if they increase that dividend to $5 over a number of years, that's a 5% yield on your initial cost of $100. And you probably got some price appreciation. You got a better company. And so your income stream has gone up. You probably had some good risk adjusted returns in your underlying stock. And you're in a better situation, if you're a conservative investor that's looking for a quality company.

Foerster: Yeah, dividend growth certainly can be a great indicator of high-quality businesses. And certainly, the example you gave of a company that went from a $1 dividend, to a $5 dividend, not only did you get out a really strong yield on cost, but also probably had a lot of appreciation, because that was probably a company that was generating high-quality earnings. So maybe you could talk a little bit about some examples of stocks that align with some of those concepts.

Azeez: Sure. Yeah. I'll give a few examples. I mean, a very simple, obvious example would probably just be Walmart, right? One of the biggest retailers in the world. Huge footprint. Great balance sheet. The type of company that in this environment probably comes out on top, the ability to take market share in a downturn, the ability to offer value to customers, particularly in an environment where prices are going higher, a company that can make investments in infrastructure.

A company that can make investments in online [operations]. Just a lot of financial firepower, and consistency. And a long-term track record that's going to allow you to, again, have both current income, and a [solid] management team, and an opportunity to grow their business through many, many market cycles, right?

That's sort of an obvious and clear example. A less obvious example I'll point to is a company that we've owned for a number of years, Parker-Hannifin, historically, a short-cycle industrial company. They made a pretty good acquisition a few years ago, to diversify their business into aerospace.

The business is about 30% aerospace. So, the beauty here is that you had a company that was trading at an attractive valuation relative to some other peers. They made a very good acquisition, took on some debt to do it. Diversified their business into a higher-margin different cycle, in terms of the aerospace cycle, which is not aligned with the short-cycle industrial cycle.

So, it took some of the cyclicality out of the business. They've been able to generate strong returns, continue to increase the dividend. Still trades at an attractive multiple relative to peers, when you can argue that they should probably trade at a higher multiple, given the consistency of the business. So those are sort of two quick examples of companies, one quite obvious, the other one maybe less so.

Foerster:  So, good stuff. And with that, I think we can wrap things up. And I think I'll just say thank you, Darnell, for joining this podcast today. Some really interesting insights during what is a very volatile time in the market. But some really important insights for equity investors around quality investing and giving some great examples of kind of maybe some higher ground right now. But definitely look forward to having you back again.

Azeez: Thank you, Brian. Happy to be here.

Foerster: Okay. Great. So, thanks, Darnell. And for listeners wanting to learn more about Lord Abbett's views on the markets, please visit the Insights section of lordabbett.com. We actually have a number of papers that the team has written on value and dividend investing, that touch on a lot of what we discussed here today.

And lastly, we'd also like to hear from our listeners. If you have any comments about today's podcast, or ideas for future podcasts, we welcome your thoughts. Just email Podcasts@lordabbett.com. So we'll leave it there. This has been Brian Foerster, with The Active Investor podcast. And thank you for listening.