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

By Joshua Aguilar | Associate Equity Analyst

The vast majority of our

have never been mistaken for dividend investors. That said, a handful of them--

Warren Buffett at

As you may recall from our previous dividend-themed articles, when we screen for top dividend-paying stocks among the holdings of our Ultimate Stock-Pickers we try 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 the dividend-paying stocks held in the portfolios of our Ultimate Stock-Pickers and then narrow it down by concentrating on firms that we believe have competitive advantages, which, in our view, should allow them to generate the excess returns they'll need to maintain their dividends longer term.

We also look for firms where there is lower uncertainty on our analysts' part regarding their future cash flows. We accomplish all of 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 our filtering process is complete, we create two different tables--one that reflects the top 10 stocks with the highest dividend yields and another that represents the stocks that are the most widely held by our top managers while also paying dividends in excess of the S&P 500. In our view, finding stocks that are yielding more than the benchmark index and operate in more stable industries where there is less uncertainty surrounding their future cash flows should offer some downside protection for investors. With markets at or near all-time highs and interest rates still at lower-than-normal levels, many investors are left searching for yield wherever they can find it. We should note, though, that the dividend yield calculations in each of these two tables are based on regular dividends that have been declared during the past 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.

Looking back to our list of top 10 dividend-yielding stocks from last time around, we note that five names--wide-moat rated

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

Despite concerns over the fractured state of politics in Washington, the S&P 500 TR Index has risen over 13.1%, as investors have shrugged off such worries and continue to allocate dollars to equities. While not all stocks have recovered--with the Healthcare, Energy, and Communication Services sectors trading in aggregate at a discount of between 10% to 20% of our fair value estimates--many have rallied. Several sectors that have traditionally been associated with yield and safety--like Utilities and Consumer Defensive--continue to be bid up in the process. Searching for yield in this type of environment can be fraught with risks, including everything from price risk to the risk that a firm cannot meet its commitment to its dividend. In an effort to offset some of these risks, we eliminate stocks with higher uncertainty ratings from our screening process. Even after doing this, we're still looking at seven out of our top 10 dividend-yielding names trading at 95% or more of our analysts' fair value estimates, which, if bought at today's prices, would potentially diminish the opportunity for outsized total returns for long-term investors. With that in mind, we expect to focus on the names that have both a solid yield and a more favorable price to fair value ratio.

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

Looking more closely at the list of top 10 widely held securities that met our criteria for dividend-paying stocks this time around, there was less overlap with our list of top 10 dividend-yielding stocks, with only wide-moat rated Wells Fargo and narrow-moat

, the majority of names on our list of top 10 widely held securities are held by 11 or more funds. While our top managers remained net sellers for the period, as they were in the prior five quarters, the buying activity that did occur was focused to some degree on these higher yielding names.

With valuation and safety being a top concern for investors, especially with markets again hovering near all-time highs relative to normalized interest rates, we continue to believe that the best way for investors to protect their capital is to invest in quality businesses trading at attractive prices. As such, we focus on names whose business prospects have a lower uncertainty, along with defensible moats, and that are currently the most undervalued--a list that includes wide-moat rated

Wide-moat rated Microsoft is the most widely held of our top 10 dividend-yielding stocks for the period. The stock currently trades at a 9% discount to our analyst's fair value estimate. Morningstar analyst Rodney Nelson recently raised his fair value estimate to $83 per share, a reflection of his rosier outlook for the firm's two flagship cloud properties: Office 365 and Microsoft Azure. With Office 365, Nelson believes that Microsoft has diminished a substantial amount of migration risk in its enterprise customer base by building a comprehensive set of cloud services under the Office 365 umbrella. He thinks that this franchise will follow a similar path to

In the case of Azure, Nelson believes that Microsoft has solidified itself as one of two long-term strategic public cloud vendors, alongside

Wide-moat rated United Technologies is another one of our top 10 dividend-yielding stocks, with four top managers holding the name. The stock currently trades at a 16% discount to Morningstar analyst Barbara Noverini's fair value estimate. Noverini believes that the name is poised for growth as secular tailwinds support long-term expansion across its four operating segments. She recently raised her fair value estimate to $134 from $129 on the heels of United Technologies' announced purchase of narrow-moat rated aerospace supplier

Noverini thinks this move makes strategic sense because it broadens United Technologies' aerospace portfolio, which remains highly dependent on the geared turbofan engine. That said, she thinks the deal seems a touch expensive. Noverini points to the acquisition price of an enterprise value/EBITDA multiple close to 14 times. This contrasts with other large aerospace deals of around 13 times according to PitchBook data. The acquiring firm pegs cost synergies at $500 million. Noverini points out that United Technologies once delivered $500 million in cost savings on its 2012 Goodrich acquisition, which was about 6% of Goodrich's operating costs. Based on this, Noverini assesses that the proposed cost savings seems realistic, albeit slightly stretched, since they equate to a slightly higher percentage of Rockwell's overall operating costs at 7%. Compounding this issue, analyst Chris Higgins believes Rockwell is very well run and as such, cost savings may prove difficult to find.

Nevertheless, Noverini believes that United Technologies will increasingly trade like an aerospace stock and estimates it will generate roughly 60% of its 2019 revenue from aerospace and defense. This makes Noverini question what's in store for OTIS and climate, controls, and security, or CCS. She forecasts these segments at lower growth rates but higher margins than the aerospace business. Furthermore, given the limited overlap between the two companies' product lines, Noverini doesn't expect any antitrust challenges. That said,

Omnicom is the last of the names we are highlighting from our top 10 list of dividend-yielding stocks. The stock, which is making a first-time appearance, currently trades at a 14% discount to analyst Ali Mogharabi's fair value estimate. The narrow-moat firm is the second-largest player, based on annual revenue, within the advertising space. In Mogharabi's view, Omnicom holds valuable intangible assets around its holding company's brand equity and the strong reputations of its various advertising agencies around the world. Mogharabi also believes that the firm's continuing investments in consumer data accumulation and analysis give it a sustainable competitive advantage. Finally, and to a lesser extent, Mogharabi thinks the firm benefits from customer switching costs associated with further integration of the firm's resources with its clients' marketing departments. Given the utilization of the firm's moat sources and overall execution, Mogharabi believes that Omnicom will earn excess returns on capital for at least 10 years.

Omnicom's performance during the second quarter of 2017 exceeded Mogharabi's expectations on both the top and bottom lines. While Omnicom and its peers are facing disruption in the ad space, brought forth by technology and consulting, Mogharabi believes their data and analytics investments allows them to compete effectively by combining their expertise in creativity with changes in the advertising market. Consolidation within the fragmented industry has resulted in five companies, including Omnicom, generating nearly 30% of total global ad revenue. Mogharabi believes that three factors drove this space toward consolidation: globalization, the emergence and growth of digital media, and more cost-control initiatives taken by clients. In contrast to peers, Omnicom has attained its market share position more through organic growth, as opposed to pursuing inorganic opportunities. Mogharabi expects Omnicom to maintain its market share position as it generates competitive organic growth, continues to make acquisitions, and increases focus on the faster-growing emerging markets and the overall digital ad markets.

Examples of promising sources of growth Mogharabi points to include the addition of large accounts, such as

Wells Fargo is the only name from our top 10 list of widely held, dividend-paying stocks we are highlighting. While we extensively profiled the name in our last issue, analyst Jim Sinegal recently published some additional insights about the bank, which trades at a 33% discount to his fair value estimate. The bank announced that a more intensive review of customer accounts found 3.5 million potentially fraudulent accounts opened between January 2009 and September 2016. While Sinegal acknowledges that the absolute number of faulty accounts is large, problems occurred with just 2.1% of total accounts reviewed, even while using a more comprehensive methodology to look for problems.

Additionally, Sinegal points out that only 190,000 of these accounts actually incurred any fees, and as a result, the bank is refunding just $6.1 million of revenue generated by these accounts to customers. In Sinegal's view, this supports his thesis that the vast majority of Wells' revenue comes from legitimate sources. Sinegal believes that a more well-rounded sales incentive program is likely to reduce the cost of wasted employee time, improve front-line morale, and result in higher long-term shareholder value over time. That said, Sinegal acknowledges that changes in company culture will not happen overnight for Wells. He also adds that additional misdeeds are likely to come to light as Wells Fargo remains in the spotlight for the wrong reasons. Given enough time to repair its reputation, Sinegal is still convinced the stock remains attractive, particularly in tandem with its current dividend yield. Only one U.S. lender with more than $50 billion in assets has produced higher returns on average assets over the past decade than Wells Fargo. Sinegal continues to believe that the biggest factor contributing to the bank's profitability is its high-quality deposit base. Only two competitors even relatively comparable to Wells' size have funded their balance sheet at a lower cost over the past decade. Customer behavior metrics measured since the crisis was uncovered continue to confirm Sinegal's view that this cost advantage remains intact.

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Disclosure: Except for Berkshire Hathaway (BRK.B), Joshua Aguilar has no ownership interest in any of the securities mentioned here. Eric Compton has no ownership interest in any of the securities mentioned here. 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.