10 Top Dividend Stocks for 2023

Key Takeaways

• It’s been a pretty good year thus far, depending on the index. The Morningstar US Market Index was up about 15%. It’s been a really concentrated performance this year.
• At the beginning of 2022, we were looking for a slowing rate in economic growth, the Fed was tightening monetary policy, we expected interest rates to rise, and we were seeing already hot inflation and expected that to continue. Coming into 2023, according to our numbers, the market was about 16% undervalued.

David Harrell: Hi, I’m David Harrell with Morningstar Investment Management. And I’m joined once again by Dave Sekera, who is the chief U.S. market strategist for Morningstar.

Dave, thanks for being here.

David Sekera: Of course. Always good to see you, David.

How Has the U.S. Equity Market Performed in 2023?

Harrell: We last spoke back in January. We were coming off of 2022, a year that was a tough year for the U.S. equity market. I think the overall market was down 18% on a total return basis. But it was a slightly better year, actually substantially a better year for dividend-paying stocks. And we saw a lot of dividend indexes actually eked out a small gain for the year. Now it’s nearly six months later. The U.S. market is doing well on a total return basis. Through the middle of June, we’re up about 15% or 16%, depending on the index. But dividend indexes are lagging that by about 10 percentage points or even in the red for the year to date. So, what’s going on here?

Sekera: Well, as you mentioned, it’s been a pretty good year thus far this year, depending on the index. Personally, I watch the Morningstar US Market Index. And last I checked, that was up about 15%. But the thing is, it’s been a really concentrated performance this year. Really only a handful of stocks have really driven the market gains. So, in fact, if we do an attribution analysis of that index, what we notice is there are seven stocks that account for at least three quarters of the gains that we’ve seen thus far this year. A lot of people now are calling them The Magnificent Seven—those seven stocks being Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta and Tesla. Now, each of those, we thought were very undervalued coming into the year. So, of those seven, six of them were actually 4- and 5-star-rated stocks. Only one was a 3-star-rated stock.

Now, at this point, they’ve all rallied so much that we really don’t see a lot of upside left in those seven. So, specifically, right now, only one of them is a 4-star, that being Alphabet, four of them are 3-stars, meaning fairly valued, and two of them are actually at 2 stars. Now what’s driven a lot of this performance this year is a lot of market excitement regarding artificial intelligence. And so, they’ve been the biggest beneficiaries of that. What we’ve seen is the rest of the market has really lagged behind. And I think that takes into account also our view going forward is that, while the economy has been a little bit stronger than expected at the beginning of the year, we still expect pretty stagnant economic performance in the second half, which of course will weigh on earnings growth and that in turn then could drive some negative market sentiment. So, things like the value category is only up a couple percent, whereas the growth category, which is most of those stocks, I think is up 25% year-to-date. So, with value struggling, and of course, that’s where you see a lot of those high dividend-paying stocks, we do see actually a lot of opportunities for investors. In the value category, according to our numbers, that’s still about 15% undervalued. And of course, a lot of high dividend-paying stocks within value that we see as really being 4- and 5-star-rated.

Harrell: Right. And those seven stocks that you mentioned, I think off the top of my head, only two of them are dividend-payers and they both yield less than 2%.

Sekera: Right. Yeah, I would not put them in really a high dividend-paying category.

Harrell: Right. So, they’re not going to show up in your dividend indexes or portfolios for the most part.

Sekera: Exactly.

Headwinds the U.S. Market Has Faced

Harrell: I know over the past year-and-a-half, you’ve been talking about some of the headwinds the U.S. market has faced. Just wanted to get an update on that and if those headwinds are still there and what they mean for dividend-paying stocks.

Sekera: Yeah. So, at the beginning of 2022 is when we really started identifying those four different headwinds. Of course, at that point in time, we were looking for a slowing rate in economic growth, the Fed was tightening monetary policy, we expected interest rates to rise, and we were seeing already hot inflation and expected that to continue. And all of those really did play out in 2022. I do think the Morningstar US Market Index was down about 20%. Now, we do think that the market sold off a little too much by the end of 2022. So, coming into 2023, according to our numbers, the market was about 16% undervalued.

Now at the beginning of 2023, in our 2023 outlook, we noted that those headwinds really had started to abate, that they had really been dying down, but at that point they hadn’t turned into tailwinds yet. And so, when I’m thinking about this year and now looking forward into the second half of the year, while the economy had been stronger than expected in the first half, again, we’re looking for pretty much zero GDP growth for the rest of this year. The Fed at this point has paused any additional tightening. We’ll see whether or not they hike rates maybe one or two more times before the end of the year. Inflation does continue to keep moderating. It is at least on a downward path, albeit not slowing as fast as people would like. And I think from an interest-rate perspective, interest rates have probably pretty much peaked. If they go up much from here, it’s probably not all that much. So, again, those headwinds really have died down. Maybe at the end of this year, some of those headwinds could start turning into tailwinds. I know our U.S. economics team would actually look for the Fed to probably turn around and start cutting rates maybe as early as this December.

10 Dividend Stock Picks

Harrell: When we spoke back in January, you gave us 10 dividend stock picks, and I wanted to revisit those. I believe you had divided them into three groups. And the first was stocks that had wide or narrow economic moat ratings from Morningstar analysts, and they also had a low or medium uncertainty rating. And I believe one of those was USB, which is one of the largest regional banks.

Sekera: Yeah, it’s been a tough year for U.S. Bank. And in fact, it’s been a tough year for all the regional banks. And of course, we did have the failure of Silicon Valley Bank, which kind of kicked off the crisis that we saw amongst the regional banks earlier this year, and U.S. Bank certainly was impacted by that as well. Right now, it looks like the stock is down about 23% year-to-date. Now, we did end up cutting our fair value a little bit. We moved it from $60 a share down to $53. And that takes into account higher funding costs that we’re expecting, as they probably have to do more short-term debt funding as opposed to the deposit funding, which is a much lower cost for the banks. But other than that, it’s still a 5-star-rated stock, trades at a 37% discount to our fair value. We still maintain that wide economic moat. It does still have that medium uncertainty rating. And the dividend yield at this point is 5.75%. So, from my point of view, that’s still a really attractive dividend yield.

Now, thinking about the company itself, we are projecting sequential earning decline over the next three quarters before that probably bottoms out and then starts to come back probably by the middle of next year. But thinking through the bank in and of itself being one of the larger, if not the largest, of the regional banks, we don’t think it’s going to be subject to as much deposit flight as you might see at some of the smaller ones where people are going to be more concerned about those banks as a going concern. And then, lastly, I do think U.S. Bank, from a fundamental point of view, we do expect that bank over the long term to be able to generate 15% returns on tangible common equity. That’s well and above its 9% cost of capital. And in fact, those types of returns probably put it toward the top of the pack for the regional banks. So, again, I’m still very comfortable with U.S. Bank. I would say with the regional banking sector, in our view, the sector is under stress, but it’s not broken.

Harrell: This is an example perhaps of an overreaction by the market to the short term?

Sekera: In our view, yes.

Harrell: What about Dominion Energy? I know that was another of the stocks in this group.

Sekera: The utility sector has traded down this year as a sector, and Dominion has also traded down along with that. Now, to some degree, I think for the past few years under the zero-interest-rate regime that we had, a lot of people were using utilities almost as a fixed-income substitute. So, now with bond yields being so much higher, I think a lot of people are now getting out of utilities and moving back into some fixed income. So, I think we’ve seen that play out beginning of this year. But Dominion is down, unfortunately, 13%, but it’s still a 4-star-rated stock, trading at a 10% discount to our fair value, which is actually one of the larger discounts that we’re seeing across our utility coverage right now. Narrow economic moat, medium uncertainty. So, again, I think what the market is concerned about in this one is between how much of a discount they’re trading and where the dividend yield is today. I think some people might be concerned that they may have to cut their dividend at some point in time in the future. I did talk to our analyst that covers that. That’s not what we foresee. We do think that they will be able to maintain that dividend going forward.

Harrell: And I believe Verizon has a narrow economic moat as well as a low uncertainty rating.

Sekera: Yeah. In communications, the traditional media and communications sector has been under some pressure thus far this year as well. So, Verizon is down 9% year-to-date. Now it’s better than AT&T, which I think is down 15% or 16%, its closest competitor. But having said that, it’s now up to a 7.2% dividend yield. It’s a 5-star-rated stock, 36% discount to our fair value. So, I think that’s a really good combination of plenty of margin of safety to the downside from here as well as that high dividend yield, narrow economic moat, low uncertainty. And thinking through the wireless sector, longer term, we think there’s going to be much more rational pricing, much more rational competition. We did see the merger between T-Mobile and Sprint. So, there’s really now the three main players in the wireless area. I know our analytical team is looking at that much more-rational pricing going forward, and so they think that we’re going to see better performance out of all three but specifically in this case Verizon going forward.

Harrell: You also had Kellogg and Clorox in this group.

Sekera: Kellogg has unfortunately fallen as well. So, it’s down 8% year-to-date. And I think a lot of the market concern there is really more short term in nature. Kellogg has been under some pressure putting through price increases just to try and offset the amount of inflation in their own inputs. So, that’s taking some time to work its way through the systems. We are definitely seeing some operating pressure there. But we do think that, over time, based on the brand portfolio that they have, that they will be able to get back to more-normalized operating margins. And even longer term, one of the things that we really like about Kellogg with that portfolio of brands is that they have one of the best setups as far as brands that are really dedicated to the emerging markets, which of course will be faster growing than a lot of the U.S. markets as well. So, thinking about Kellogg, it’s a 4-star-rated stock, trades at a 22% discount to our fair value, 3.5% dividend yield, again, a company with what we think has a wide economic moat and a medium uncertainty.

And then, following up on Clorox. So, that one has actually been a pretty good performer. It’s up 11% year-to-date, another wide-moat, medium uncertainty stock. That one now has actually moved to a 3-star rating from being a 4-star at the beginning of the year. It’s only trading at about a 6% discount to fair value. So, while I do still think it’s a pretty solid investment here today, I’d just caution investors: At this point, I really expect more of the rate of return to equal its cost of equity over time. So, in that case, I do think that what investors could do would be to swap out of Clorox and into a substitute stock. The one that I’ve picked here is Kraft Heinz. And so, with that, I do have to note it does not have an economic moat, but it does have a medium uncertainty. Now, typically, of course, we do prefer to look for stocks with a narrow or a wide economic moat. But in this case, it is trading at a 30% discount to fair value, and it pays a 4.4% dividend yield. I do think that between that dividend yield as well as that much margin of safety to our long-term intrinsic valuation, that it is a good investment for investors today.

Harrell: OK. And your next group were a couple of stocks—or actually three stocks—that you believe could benefit from some long-term secular trends. And the first was Eastman Chemical.

Sekera: Eastman is close to unchanged. I think it’s down 1% or 2% year-to-date. So, it’s still a 4-star-rated stock, and it trades at what I consider to be a very healthy margin of safety at 39% right now. Pays about a 4% dividend yield. So, narrow moat, although because it’s in a more cyclical industry, it does have a high uncertainty. But at the end of the day, while there may be some short-term pressures if the economy is stagnant in the second half of the year, we do think, based on the portfolio of products that they have, we are looking for long-term performance out of this company.

Harrell: Digital Realty Trust owns and operates data centers, and it’s structured as a real estate investment trust, or REIT.

Sekera: That one has done OK. I mean, it’s up 4% year-to-date. It’s a 4-star-rated stock, trades at a good 23% discount to our fair value, rated with a narrow economic moat and high uncertainty, 4.6% dividend yield. And so, the commercial real estate sector has a lot of negative connotations around it right now in the marketplace. Specifically, people are very concerned about urban office space and how much valuations. So, that’s really bled across the entire real estate sector. With Digital Realty, I’m actually very comfortable with that one with the data centers. It’s a very different business model than, of course, the office real estate. And then, one thing I’d note with Digital Realty, I think the whole artificial intelligence play as that grows could actually be a benefit in the long term for Digital Realty.

Harrell: Got it. And then, the last in this group was Medtronic. Medtronic recently announced a dividend increase, but it was smaller, 1.5%, than I’m sure many investors were hoping for. It appears that management is taking a cautious approach this year with its dividend increase.

Sekera: Medtronic had a pretty good year. The stock is up 14%. So, with that little rally there, it’s actually moved from a 5-star rating down to a 4-star rating, but again, still indicating that we think it’s undervalued, trades at about a 21% discount still to our fair value and about a 3.10% dividend yield. Now, Medtronic, it’s still one of my favorite stocks in the medtech space, specifically levered toward the aging of the baby boomer generation. One of the other things, too, recently with that stock is I do think it has some good short-term catalysts. So, UNH, one of the insurance providers, had recently been out there and made some commentary that they’re seeing a lot more service costs coming through the system. And I think what that might be highlighting is that we’re starting to see maybe a lot of delayed procedures from the pandemic now coming through. I think a lot of the device makers are going to see a good tailwind as that plays through. And I think Medtronic is going to be one of those beneficiaries.

Harrell: And our last group is one that you defined as stocks that had some higher yields, some very attractive yields, but were perhaps a little bit riskier in terms of their earnings stability or earnings growth. The first was Equitrans, which is a midstream energy company.

Sekera: Equitrans stock has really done phenomenal this year. It’s up about 43% year-to-date. Again, narrow economic moat, but of course, being in that sector, a high uncertainty rating. And that stock also has moved from a 5-star down to a 4-star, but it still trades at a pretty decent discount to our fair value. So, we still see upside there as far as price appreciation. Now that dividend yield has come down with the stock going up as much as it has but still a healthy 6.3% dividend yield. At a 36% discount to our fair value, again, still I think plenty of margin of safety and still gives you that high yield. But again, I do think this is going to be a little bit riskier of a play, potentially more volatile than you might see in some of those other names we’ve discussed.

Harrell: Your second name in this group was Intel, which has done phenomenally well on a total return basis this year but a little less attractive now for income-focused investors.

Sekera: Right. And with Intel, we did see them cut their dividend in February. But having said that, the stock again was up about 25% year-to-date. So, again, I think it’s one of those ones where that combination of what we thought was going to be a better dividend yield, married with that very large discount to fair value, has worked out for investors in this case. But I would say with as much as that stock has run up, it’s not nearly as undervalued. It’s a 3-star-rated stock at this point. So, I do think this is a good one where investors could look to swap out of that, especially the investors who are more interested in a higher dividend yield.

So, in this case, one I was looking at is Gilead. So, again, it’s a healthcare name. It’s a little bit different than what we saw in the technology sector. But again, 4-star-rated stock, wide economic moat, medium uncertainty. It’s trading at about a 20% discount to our fair value at this point. Pays a 3.9% dividend yield. And one of the characteristics I like about this is: I read the equity analyst research report, and she noted that she thinks this company is “poised for maintainable growth.” And thinking about that from a dividend investor portfolio view, I think that’s a really good solid way to think about it. The company has about a 50% payout ratio. I think that’s a good blend for shareholder rewards between being able to do share buybacks while we think that shares are undervalued but also then be able to maintain that dividend going forward.

Harrell: That’s great, Dave. Thanks for joining us and sharing your insight.

Sekera: Of course. Well, thank you. Always good speaking with you, David.

Harrell: I’m David Harrell with Morningstar Investment Management. Thanks for watching.

Watch “4 Undervalued Wide-Moat Stocks With Defensive Traits” for more from Dave Sekera.