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The Ultimate Stock-Pickers’ Top 10 Dividend Stocks
These top managers continue to focus on higher-quality dividend-paying stocks in a market that has become more volatile of late.
The Morningstar Ultimate Stock-Pickers Team| 03-17-15| 06:00 AM

By Greggory Warren | Senior Stock Analyst

Despite stumbling a bit in January, the U.S. equity markets (as represented by the S&P 500 TR Index) rebounded in February, and have so far held on to those gains in what has turned into a difficult March, with the benchmark up just 0.2% on a year-to-date basis at the end of last week. With investors continuing to focus on what the Federal Reserve will do next with interest rates, we've seen the markets take a dive when good news comes out on the U.S. economy (like last week's employment report), and rally in the face of poorer economic news (like the retail sales report that came out for February). Add to this a historic rise in the U.S. dollar versus other currencies, as well as another drop in oil prices, and the stage has been set for more volatility in the near term than we've seen overall the past several years. Bob Johnson, Morningstar's chief economist, believes that the market is spending way too much time on the "when" part of the rates question, and not nearly enough on the "how much, how long, and in what increments" issues. He thinks that any delay in Fed rate increases (while perceived favorably by investors) only means that future increases will be larger and/or subsequent rate increases could be spaced much closer together--that is, assuming that the U.S. economy continues to recover.

That said, all of the uncertainty about when interest rates are going to start rising has made it that much harder for dividend-focused investors to figure out what to do with their portfolios. The vast majority of our Ultimate Stock-Pickers have never been mistaken for dividend investors, but a handful of them-- Amana Trust Income AMANX,  Columbia Dividend Income LBSAX,  Oakmark Equity & Income OAKBX, and  Parnassus Equity Income PRBLX--are more focused on income-producing stocks in their pursuit of investment gains. We could also argue that Warren Buffett at  Berkshire Hathaway BRK.A/BRK.B has shifted his investment portfolio to be more of an income generator. According to this year's annual report, Berkshire received around $1.6 billion in dividends from its equity investments during 2014, up from $862 million three years prior. This does not include the $3.5 billion that the company received as a cash distribution from its Burlington Northern Santa Fe subsidiary last year. It is also noteworthy that Berkshire receives no dividend from its energy/utilities operations, Berkshire Hathaway Energy, which has been able to use the cash that it would normally pay out to public shareholders to reinvest in its business.

As you may recall from our last dividend-themed article, we spent a fair amount of time talking about the virtues of utilities, especially with regards to the impact that rising and falling interest rates can have on dividend-paying stocks. Our Utilities team had just collected some interesting statistics showing that during the 20 years that ended on June 30, 2014, utilities consistently produced 8%-9% annual total returns during two-year holding periods regardless of how interest rates moved. During those periods when interest rates fell, the average annualized return for utilities was 10.9% (compared with 7.7% for the S&P 500), with absolute returns being negative in only two periods. In addition, the sector actually produced better absolute two-year returns when interest rates were rising, with the average annualized return for utilities being 11.8% (compared with 21.9% for the S&P 500), and absolute returns being positive in every period. The key takeaway we got from their research was that although the sector's relative performance may vary, utilities have consistently produced positive absolute returns regardless of whether interest rates were rising or falling. The Utilities team was also quick to note that that there was no guarantee that this trend would continue in the future, especially given the solid performance of Utilities stocks in the last six years (in the aftermath of the 2008-09 financial crisis).

We were not too surprised, then, to see our Utilities team recently recommend that investors start selling their holdings in the sector and lock in the impressive paper gains that they've racked up in the last few years. In particular, 2014 was an exceptional year for the Utilities sector, which was up 28.7% when including dividends, well above the results of most other sectors (Real Estate and Health Care were the only exceptions) and the S&P 500 TR Index (which was up 13.7% last year). As of the end of February, the 32 regulated utilities that Morningstar covers were overvalued by more than 5%, and their median price/earnings and price/book multiples of 18.0 times and 1.8 times, respectively, were at decade highs. The group's 3.4% median dividend yield was near its lowest level in at least two decades, and well below its 4.5% average yield that has been seen during the last 15 years. While our Utilities team believes that industry fundamentals remain strong, and that dividends should keep growing, they think that if interest rates revert to their long-term averages, upwards of one third of the firms that it covers could see their stock prices drop by 15% or more. This has prompted the team to be more vocal about encouraging investors to reap some gains and wait for valuations to moderate.

What looks to be shaping into a potential trade for some income-seeking investors is the appearance of a handful of oil-related stocks-- ConocoPhillips COP,  Occidental Petroleum OXY,  National Oilwell Varco NOV, and  Exxon Mobil XOM--on our list of top 10 dividend-yielding stocks held by our Ultimate Stock-Pickers. No doubt, this is in response to the impact that the dramatic drop in oil prices has had on the price of oil company stocks the last couple of quarters, as the yields on these firms' shares have risen enough to supplant other names on the list. Even as our Energy team has reset its expectations for midcycle oil prices (from $100 per barrel to $75 per barrel for Brent crude oil), taking the group of oil-related stocks that Morningstar covers from a price-to-fair value multiple of about 80% to near 90%, there still are a few bargains in the group. Our screen of top dividend-paying stocks tries to hone in on the highest-quality names that are currently held with conviction by our top managers. We do this by taking an initial list of more than 500 different dividend-paying stocks held by our Ultimate Stock-Pickers, and focusing in on firms that we think not only have competitive advantages that should allow them to generate the cash flows they'll need to maintain their dividends longer term, but be able to do so with far less uncertainty. 

We accomplish this by screening for holdings that are widely held (by five or more of our top managers), are yielding more than the S&P 500, represent firms with Wide or Narrow economic moats, and have uncertainty ratings of either Low or Medium. Once this is done, we create two tables, one reflecting the top 10 dividend-yielding stocks of our Ultimate Stock-Pickers, and the other representing stocks that are paying dividends in excess of the S&P 500 that are also widely held by our top managers. In our view, finding stocks that are yielding more than the benchmark index, but which operate in more stable industries, where there is less uncertainty surrounding their future cash flows, should offer some downside protection for investors (which seems to be a growing concern these days). We note that our dividend yield calculations in each of these tables is based on regular dividends that have been declared over the last 12 months, and do not include the impact of any special (or supplemental) dividends that may have been paid out (or declared) during that time. 

Top 10 Dividend-Yielding Stocks of Our Ultimate Stock-Pickers

Company Name
Star Rating
Size of Moat
Current Price (USD)
Price/ FVE
T4Q DVD Yield (%)
Uncertainty Rating
# Funds Holding
# Funds Buying
Philip Morris PM
4
Wide
77.65
0.84
5.1
Low
5
1
ConocoPhil COP
3
None
61.64
0.95
4.7
High
5
1
OxyPetroleum OXY
3
Narrow
72.84
0.97
4
High
7
2
NatOilVarco NOV
4
Narrow
49.07
0.74
3.7
Medium
7
3
GE GE
4
Wide
25.04
0.83
3.6
Medium
8
4
Unilever UL*
2
Wide
42.06
1.11
3.5
Medium
9
4
McDonald's MCD
3
Wide
96.35
0.98
3.4
Medium
5
1
Sanofi SNY*
4
Wide
47.07
0.86
3.4
Medium
6
2
EmersonElec EMR
4
Wide
55.26
0.8
3.3
Medium
7
1
ExxonMobil XOM
4
Wide
83.87
0.86
3.3
Low
8
2

*Dividends for American Depository Receipts (ADRs) can be affected by changes in currency exchange rates. Our calculations also adjust for special dividends. Stock Price and Morningstar Rating data as of 03-13-15.

There have been some changes in the list of top 10 dividend-yielding stocks of our Ultimate Stock-Pickers since we last looked at them, with  Vodafone Group VOD,  Pfizer PFE, Roche RHHBY, and  Eli Lilly LLY making way for Occidental Petroleum, National Oilwell Varco,  Emerson Electric EMR, and Exxon Mobil. Yet the yields remain fairly comparable, even though the market has risen about 4% during the past six months. The list itself also remains balanced, even with Energy stocks accounting for four of the 10 top dividend-yielding stocks, with four other sectors--Consumer Defensive, Industrials, Consumer Cyclical, and Health Care--continuing to be represented. We noted the heavier buying activity in shares of  General Electric GE and  Unilever UL/UN, neither of which made our list of top 10 high-conviction purchases. However, Unilever made our list of top 25 purchases, with General Electric not falling too far off of the expanded list of high-conviction purchases. That said, General Electric was the object of two high-conviction new-money purchases during the fourth quarter.

Looking more closely at the top 10 widely held securities that meet our criteria for dividend paying stocks, which has traditionally had very little overlap with our list of our Ultimate Stock-Pickers' top 10 dividend-yielding stocks, we see a larger commitment to Consumer Defensive names-- Procter & Gamble PG,  Wal-Mart WMT, and Unilever--which have traditionally offered higher yields than other stocks and have tended to maintain greater levels of price stability during down markets. Old school Technology stocks like  Microsoft MSFT,  Intel INTC, and  Qualcomm QCOM continue to be widely held as well, with Microsoft in particular being a perennial top 10 high-conviction holding for our Ultimate Stock-Pickers during the last six years.  Wells Fargo WFC and  U.S. Bancorp USB have also been long-standing Financial Services holdings for our top managers. With both banks receiving approval for their capital plans during the Federal Reserve latest round of stress tests, they have already announced increases in the dividends they expect to pay out during the second quarter. We've also seen  Johnson & Johnson JNJ and  United Parcel Service UPS make the list in years past, representing the Health Care and Industrials sectors, respectively. We note that we are seeing far fewer Health Care stocks make the list than in past periods, but with the sector overall up strongly in each of the last three calendar years, it is understandable to see some names fall off of the top 10 lists.

Widely Held Dividend-Paying Stocks of Our Ultimate Stock-Pickers

Company Name
Star Rating
Size of Moat
Current Price (USD)
Price/ FVE
T4Q DVD Yield (%)
Uncertainty Rating
# Funds Holding
# Funds Buying
Microsoft MSFT
3
Wide
41.38
0.9
2.9
Medium
15
3
WllsFrgo WFC
3
Narrow
55.34
1.06
2.5
Medium
15
-
P&G PG
4
Wide
81.83
0.91
3.1
Low
13
2
UPS UPS
3
Wide
98.53
1.04
2.8
Medium
12
2
J&J JNJ
3
Wide
99.21
1
2.8
Low
11
-
Wal-Mart WMT
3
Wide
81.9
0.99
2.4
Low
11
3
Intel INTC
3
Wide
30.93
1.07
3
Medium
10
2
Qualcm QCOM
3
Wide
68.64
0.92
2.4
Medium
10
3
U.S. Bancorp USB
4
Narrow
44.29
0.89
2.2
Medium
10
3
Unilever UL*
2
Wide
42.06
1.11
3.5
Medium
9
4

*Dividends for American Depository Receipts (ADRs) can be affected by changes in currency exchange rates. Our calculations also adjust for special dividends. Stock Price and Morningstar Rating data as of 03-13-15.

Valuation is a bigger concern for investors right now, so we thought it best to hone in on the names on both lists that are trading at less than 85% of our analysts' fair value estimates. We believe there might be more value to be had in solid dividend payers offering investors a wider-than-average margin of safety. We've included a few of our observations below:

National Oilwell Varco

Ticker: NOV

Current Yield: 3.7%

Price/Fair Value: 0.74

Morningstar analyst Jason Stevens recently lowered his fair value estimate for National Oilwell Varco to $66 per share from $70, as a result of the change in the Energy team's long-term midcycle oil and gas price assumptions, as well as adjustments to the company's cost of capital assumptions. The biggest knock he has on equipment and services firms like National Oilwell Varco is the expectation for reduced deep-water activity, given the impact that the unconventional oil resource base has had on demand for expensive deep-water projects. This has left the future of National Oilwell Varco's flagship rig system in doubt, as the current excess supply of high-specification deep-water drilling rigs is going to get worse before it gets better. That said, Stevens has higher expectations for the rest of National Oilwell Varco's business, and while revenues are likely to decline over the next five years, he expects the current quarterly dividend to be maintained (but unlikely to be grown until oil prices recover).

Emerson Electric

Ticker: EMR

Current Yield: 3.3%

Price/Fair Value: 0.80

Morningstar reiterated its $69 per share fair value estimate for Emerson Electric following the company's release of fiscal first-quarter results. Our analysts remain impressed with Emerson's ability to generate top-line growth, noting that the strengthening of the U.S. dollar has only made the true rate of growth in all five of Emerson’s operating segments. They believe that this underlying growth, and the firm's ability to mitigate pockets of macroeconomic weakness with its balanced portfolio, both add to the width of its economic moat and provide it with the stability necessary to continue increasing its dividend, currently at $0.47 per share on a quarterly basis. Management's goal is to return at least 50% of the company's annual cash flows to shareholders in the form of dividends or share buybacks, and the firm's dividend has steadily increased each year since the 1950s.

General Electric

Ticker: GE

Current Yield: 3.6%

Price/Fair Value: 0.83

Morningstar analyst Barbara Noverini also covers General Electric, which she notes has been repositioning its business in the last several years, placing a greater emphasis on its wide-moat industrial businesses. Noverini thinks that GE’s core industrial segments still share the common theme of infrastructure development that served as the foundation for its business a century ago, but that powering the "industrial Internet" has come to symbolize the company’s future growth platform. She notes that GE’s resilience in the face of uncertain global macroeconomic conditions further supports her belief that, despite increased concentration on industrials, the portfolio’s end markets and geographic exposure are well diversified. She expects the divided, which was cut to support GE Capital in the aftermath of the 2008-09 financial crisis, to be able to grow from its current base, given the strength and positioning of the company's industrial businesses.

Philip Morris International

Ticker: PM

Current Yield: 5.1%

Price/Fair Value: 0.84

Morningstar analyst Phil Gorham believes that Philip Morris International has one of the strongest businesses in our consumer defensive coverage. The company has 28% global market share (excluding the U.S. and China), making it the largest publicly traded tobacco company in the world, and owns seven of the world's top 15 brands. Its unmatched scale, customer loyalty to the Marlboro brand, and its addictive products give the firm meaningful pricing power, allowing it to produce industry-leading normalized operating margins in the low- to mid-40% range. That said, global consumption is tipping into decline, and packaging rules could threaten the pricing power of premium brands longer-term. This is part of the reason why Gorham expects the firm to spend less on share repurchases and dividend increase than it has since being spun off from  Altria MO in May 2008. Even so, he still expects Philip Morris to grow the dividend at a mid- to high-single-digit rate, in line with EPS growth in the near-to-medium term.

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Disclosure: Greggory Warren own shares of the following securities mentioned above: Altria and Procter & Gamble. It should also be noted that Morningstar's Institutional Equity Research Service offers research and analyst access to institutional asset managers. Through this service, Morningstar may have a business relationship with fund companies discussed in this report. Our business relationships in no way influence the funds or stocks discussed here.


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