3 High-Quality Undervalued Dividend Payers

Stocks have finally taken a bit of a breather during the last few weeks after an impressive runup in the first part of the year. The broad-based Morningstar US Market Index fell 1.1% during the last week and is up only 1.0% during the last month. The market seems to be having jitters over stretched valuations in some sectors and the possibility that the Fed is going to taper its quantitative easing program sooner than expected. The mild sell-off hasn't created a ton of new opportunities, but some high-quality dividend payers are starting to look attractive.

Across sectors, the pullback in stocks has been far from even. As interest rates began to rise a bit, the selling pressure was more focused on some of the higher-yielding parts of the market. During the last month, real estate (-6%), utilities (-5%), and consumer defensive (-1.3%) stocks have been among the hardest-hit while other areas such as financial-services (+4%) have actually performed quite well. 

Given the lofty valuations that these sectors commanded before the sell-off, this isn't a huge surprise. During the last month, the median price/fair value ratio for real estate fell from 1.11 to 1.04, while that for utilities fell from 1.12 to 1.02. Even with the decline in prices, these sectors aren't screamingly cheap right now. They are still trading higher than their intrinsic values, and other areas of the market such as basic materials and energy look much cheaper. But the sell-off has carved out some pockets of value in companies with appealing income potential.

It makes a lot of sense to seek out dividend payers in this market environment. First off, the payout can provide a decent yield which is nothing to scoff at today. And more importantly, over the long term the steady compounding of an increasing dividend can help provide a reasonable total return even if the market moved sideways for some time. Of course, that compounding effect only works if the dividend payments keep coming and ideally keep growing. And it's the high-quality companies with sustainable competitive advantages that are the most likely to keep paying out cash to shareholders. These firms with wide or narrow moats have structural advantages that will allow them to earn economic profits for some time, and they are less likely to be forced to cut a payment. 

We used Morningstar's  Premium Stock Screener to find some of these newly cheap, high-quality dividend payers. We looked for firms with a trailing return of less than zero during the last month, that have narrow or wide moats, that are trading far enough below their fair value estimates have Morningstar Ratings for stocks of 4 or 5 stars, and that have a dividend yield higher than 3%. Run the screen for yourself  here. Below are three names that passed.

 Clorox (CLX)   
Moat: Narrow | Fair Value Uncertainty: Low | Yield: 3.05%   
From the  Premium Analyst Report:    
While Clorox operates in categories where competitive pressures abound, its brand strength is undeniable, as nearly 90% of its portfolio holds the number-one or number-two spot. The brand equity inherent in its product lineup is further evidenced by the fact that since 2005, the firm has taken 66 price increases across its business, and 64 of those are still in place--a 97% success rate. These factors, combined with the fact that Clorox boasts returns on invested capital (which have averaged nearly 25% over the past five years) far in excess of our cost of capital estimate and solid cash flow generation, support our stance that the firm maintains a narrow economic moat.

 PPL (PPL)     
Moat: Narrow | Fair Value Uncertainty: Medium | Yield: 4.95%    
From the  Premium Analyst Report:
PPL has shifted its business profile from its competitive electricity generation to focusing on its regulated operations. Prior to the 2010-11 acquisitions of Louisville Gas & Electric, Kentucky Utilities, and Central Networks, PPL derived 75% of its earnings from its competitive supply segment. In 2013, PPL's regulated business will generate 85% of earnings before interest, taxes, depreciation, and amortization.

While this diversification offers a more stable earnings outlook, investors will be less able to partake in the upside when power prices eventually rebound. However, PPL is still able to earn higher returns than its fully regulated peers. With a widely diversified stable of service territories, and a mix of commercial and regulated assets across Montana, Kentucky, Pennsylvania, and the United Kingdom, we believe PPL is a good candidate at the right price for a core holding in an income investor's portfolio.

 Vornado Realty Trust (VNO)   
Moat: Narrow | Fair Value Uncertainty: Medium | Yield: 3.52%    
From the  Premium Analyst Report:    
Vornado employs a solid strategy of owning commercial real estate in space-constrained markets with favorable demographics, which earns it a narrow moat rating. But its willingness to invest in equity and debt securities of other companies with real estate components adds uncertainty to our analysis.

We like the characteristics of Vornado's office and retail properties, situated mainly in and around New York and Washington. We expect these markets to be good for landlords over the long term, as they benefit from constraints on building competitive supply, local, national, and foreign demand for space, and favorable demographics. Over time, we think these characteristics can support rental price increases that slightly exceed inflation. For 32 years, Vornado's core portfolio of office and retail properties in New York and Washington hadn't experienced an annual decline in cash flows, either in total or on a same-property basis. This streak came to an end in 2012, however, mainly because of weakness in the Washington market, but we think Vornado's prime property assets will generally perform better than most over the course of an economic cycle.  

All data as of June 7, 2013.