Wide-Moat Stocks with High Dividend Yields

If there was any strategy that might be considered a push-button exercise in investing, selecting a stock for a long, attractive dividend record ought to be it. When picking stocks for Morningstar DividendInvestor, I love to see a company with a long stretch of rising dividend payments. Combine decades of consistent payments, predictable dividend increases and a decent yield, and what could be left worry about?

The trouble is that this investment case isn't yet complete. While the dividend adds an impressively sharp instrument to the investor's toolbox, it isn't enough to buy a stock based on dividend history alone. It's still critical to obtain one more characteristic of a well-chosen investment: an economic moat.

Frequent readers of Morningstar stock research will recognize the concept, but it bears repeating: An economic moat is the competitive advantage (or better yet, advantages) that allows a firm to earn superior profits on a sustainable basis--and to protect those profits from competitive pressures.

Long dividend records and the presence of a moat frequently run together, but a favorable dividend record cannot itself be the moat. In fact, when the dividend record breeds complacency, it's as likely to hurt investors as it is to help.

 Winn-Dixie  was a textbook case of a longtime dividend-payer with no economic moat. I covered the stock back in 2001, and the situation made quite an impression on me. Here was one of the largest supermarket chains in the country, with seven decades of dividends behind it, available at better than a 3% yield when the S&P was offering half that.

But Winn-Dixie was getting clobbered by the likes of  Wal-Mart (WMT), whose ultralow costs negated whatever competitive advantage Winn-Dixie once had. The dividend record pretended to offer investors some comfort, but as a safety net that record was full of holes. Soon enough, the company was forced to slash its dividend 80% and then omit it entirely. The shares have since lost more than 80% of their early-2001 value.

By contrast, a wide economic moat puts the dividend in good stead. Consider  Pitney Bowes (PBI), the nation’s largest purveyor of postage meters. In recent years it has been earning a splendid 50% return on equity--and its dividends alone have been running at some 20% of equity. If Pitney Bowes had no moat, any other firm could (hypothetically) enter the postage-meter business and expect the same 50% return. Of course, the added competition would drive prices down, eroding Pitney's earning power and eventually putting those fat dividends at risk.

Fortunately for the firm and its shareholders, Pitney Bowes has a wonderfully wide moat. A potential competitor would have to get licensed by the U.S. Postal Service, achieve the same size and scale as Pitney has now, and displace millions of loyal Pitney customers. Thus we can have a large measure of confidence that these fat economic profits--and the substantial dividends they support--should go on and on and on.

In Morningstar DividendInvestor, our newsletter for the income-oriented crowd, we require at least a narrow economic moat before recommending a stock. As far as I'm concerned, a truly secure dividend-payer has to have one. Sure, this rule eliminates some high-yielding stocks from the ranks of automakers, chemical manufacturers, and supermarket chains, but I figure that what might be lost by choice is more than made up for with quality.

A search for wide-moat companies--the cream of Morningstar's coverage list--reveals a handful 4- and 5-star stocks offering above-average yields. Five-star names are in short supply these days, and that's no less true for the high-yield quadrant. Right now there are only two stocks that have a wide moat, a Morningstar Rating of 5 stars, and a yield of more than 3%:  Fifth Third Bancorp (FITB) and  Diageo (DEO). Both stocks are, not surprisingly, holdings in DividendInvestor's model portfolio. Below are four other stocks with high ratings, wide moats, and high yields. 

 J.P. Morgan Chase (JPM) 
3.8% yield
With a $1.1 trillion balance sheet, this firm has the heft to compete with any rival.

 Unilever (UL)
3.7% yield
Strong brands and diverse businesses earn this consumer-goods giant our wide-moat rating.

 Merck  (MRK)
4.9% yield
The company has an unparalleled drug portfolio, a best-in-class salesforce and enormous financial and administrative resources.

 Wells Fargo (WFC) 
3.1% yield
This is an impressive banking franchise with a sound strategy for generating solid returns.

A version of this article appeared on Feb. 4, 2005.