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By Jeremy Glaser | 03-23-2013 12:30 PM

Top Picks From Morningstar's Strategists

Morningstar investment experts Russ Kinnel, Matt Coffina, Josh Peters, and Sam Lee answer viewer questions about the current market and the best opportunities in stocks, funds, and ETFs today.

The following is a replay from the 2013 Morningstar Individual Investor Conference.

Jeremy Glaser: Hi, I am Morningstar markets editor Jeremy Glaser, and welcome to Top Picks from Morningstar Strategists. We're going to get some great ideas for your portfolio. Just as a reminder, you can ask questions to our strategists in the box to the right of your player.

I'd like to introduce our panelists today. First we have Josh Peters, he is the editor of Morningstar DividendInvestor and also the director of equity income strategies; we have Russ Kinnel, he is our director of mutual fund research and editor of Morningstar FundInvestor; Matt Coffina, editor of Morningstar StockInvestor; and finally Sam Lee, he is editor of Morningstar ETFInvestor. Gentlemen, thanks for joining me today.

So, we've gotten a slew of questions about income, and where you can find income in today's environment. So, I am going to start with you, Josh, obviously, your portfolios are very focused on finding dividend income. What kind of opportunities are you seeing in dividend-paying stocks right now?

Josh Peters: I think the most important thing I want to emphasize right now is quality. We've had a big run-up, a big recovery in the stock markets over the last couple of years, valuations across the board when you are looking kind of on a historic bottom-up type of framework don't really look all that attractive. But I like to go back to what Ben Graham said and many of his pronouncements in editions of The Intelligent Investor. He really warned against the idea that you take second-rate securities to try to juice your return. There is certainly the risk that you could overpay for a high-quality security, but he pointed out the bigger risk is that you buy secondary securities at fair-weather prices, and then you go on to have disappointing results.

So, even though there is not whole lot of out-and-out bargains, which is obviously the kind of environment that I would prefer, a name like Philip Morris International in this environment trading a little bit below our fair value estimate, yielding around 4%, a great wide-moat franchiser, I like that name. A couple of names that are still in buy territory for my purposes, Wells Fargo recently raised its dividend for second time this year showing a great commitment to getting that dividend back up and running after having to cut it a few years ago, a great franchise there. General Electric is another name that the dividend is continuing to recover from the crash; it still yields over 3%. There are names out there, but it isn't the kind of environment where you can say "Well, I like energy across the board," or "I don't want to own any utilities stocks." It's really a matter of bottom-up stock-picking and focusing on quality.

Glaser: Is this a case when individual stocks might make more sense than a basket of stocks? Sam do you see any dividend ETFs that maybe are attractive right now?

Sam Lee: I agree with Josh in that there is really nothing that sector wide is attractive, but if I had to go with a dividend-paying stock ETF it would be either, Vanguard Dividend Appreciation, VIG, and dovetailing with Josh's point, it's really a basket of high-quality dividend-paying stocks that have grown their dividends 10 years straight. So, it weeds out all the junky companies, and you can really be sure that those dividends are going to stay around for a long time.

Glaser: But how about dividend growth? What are your expectations for the prospect of seeing these kind of high-quality stocks being able to keep growing out that payout? Or are corporate profits already at a level where they are not going to be able to keep growing them and then grow that distribution?

Peters: Well, I think we're seeing some positive signs on that front, that the payout ratio, the proportion of earnings in the S&P 500 that is paid out as dividends, is starting to creep up. A couple of years ago we actually hit an all-time low of about 29%-30%. We're making some progress there. As we see more companies initiating new dividends, raising small dividends and more meaningful ones, I think that creates more opportunities for income investors. But for me really I want the companies that have already put that great track record out there and a company like, Johnson & Johnson, which has raised its dividend every year for many decades. The growth rate has certainly slowed from where it was a few years ago, but this is not an emerging opportunity. This is a well-established company, capable of maintaining that payout through thick and thin, continuing to raise [the payout] through thick and thin. Those are the names I really want to gravitate to rather than necessarily leaping on the newest company that just started paying a dividend.

Glaser: Russ, on the open-end side, are there any kind of dividend-focused managers, that are doing a good job in this environment. How should investors, who like to invest in those vehicles, think about this?

Russ Kinnel: I think moving up for yield in equities is a little better than in bonds where that's really been squeezed dry. So, I think funds like Vanguard Dividend Growth, one that [Morningstar director of personal finance] Christine Benz recommends all the time, it's got a decent yield, but it's also focused on companies that can grow their dividends. And that means they have to have a pretty clean balance sheet and pretty good business. So, that’s a good discipline. In emerging markets you could move to a fund like Matthews Asia Dividend as a way to get a little yield where maybe you weren't able to get yield before and in that case you are actually dialing down the risk because dividend-paying stocks in Asia are generally going to be a little less risky. So, those are two of the options I like.

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