The Ultimate Stock-Pickers’ Top 10 Dividend Stocks

By Greggory Warren | Senior Stock Analyst

Despite stumbling a bit in January, the U.S. equity markets (as represented by the S&P 500 TR Index) rebounded in February, and have so far held on to those gains in what has turned into a difficult March, with the benchmark up just 0.2% on a year-to-date basis at the end of last week. With investors continuing to focus on what the Federal Reserve will do next with interest rates, we've seen the markets take a dive when good news comes out on the U.S. economy (like last week's employment report), and rally in the face of poorer economic news (like the retail sales report that came out for February). Add to this a historic rise in the U.S. dollar versus other currencies, as well as another drop in oil prices, and the stage has been set for more volatility in the near term than we've seen overall the past several years. Bob Johnson, Morningstar's chief economist, believes that the market is spending way too much time on the "when" part of the rates question, and not nearly enough on the "how much, how long, and in what increments" issues. He thinks that any delay in Fed rate increases (while perceived favorably by investors) only means that future increases will be larger and/or subsequent rate increases could be spaced much closer together--that is, assuming that the U.S. economy continues to recover.

That said, all of the uncertainty about when interest rates are going to start rising has made it that much harder for dividend-focused investors to figure out what to do with their portfolios. The vast majority of

have never been mistaken for dividend investors, but a handful of them--

As you may recall from our last dividend-themed article, we spent a fair amount of time talking about the virtues of utilities, especially with regards to the impact that rising and falling interest rates can have on dividend-paying stocks. Our Utilities team had just collected some interesting statistics showing that during the 20 years that ended on June 30, 2014, utilities consistently produced 8%-9% annual total returns during two-year holding periods regardless of how interest rates moved. During those periods when interest rates fell, the average annualized return for utilities was 10.9% (compared with 7.7% for the S&P 500), with absolute returns being negative in only two periods. In addition, the sector actually produced better absolute two-year returns when interest rates were rising, with the average annualized return for utilities being 11.8% (compared with 21.9% for the S&P 500), and absolute returns being positive in every period. The key takeaway we got from their research was that although the sector's relative performance may vary, utilities have consistently produced positive absolute returns regardless of whether interest rates were rising or falling. The Utilities team was also quick to note that that there was no guarantee that this trend would continue in the future, especially given the solid performance of Utilities stocks in the last six years (in the aftermath of the 2008-09 financial crisis).

We were not too surprised, then, to see our Utilities team recently recommend that investors start selling their holdings in the sector and lock in the impressive paper gains that they've racked up in the last few years. In particular, 2014 was an exceptional year for the Utilities sector, which was up 28.7% when including dividends, well above the results of most other sectors (Real Estate and Health Care were the only exceptions) and the S&P 500 TR Index (which was up 13.7% last year). As of the end of February, the 32 regulated utilities that Morningstar covers were overvalued by more than 5%, and their median price/earnings and price/book multiples of 18.0 times and 1.8 times, respectively, were at decade highs. The group's 3.4% median dividend yield was near its lowest level in at least two decades, and well below its 4.5% average yield that has been seen during the last 15 years. While our Utilities team believes that industry fundamentals remain strong, and that dividends should keep growing, they think that if interest rates revert to their long-term averages, upwards of one third of the firms that it covers could see their stock prices drop by 15% or more. This has prompted the team to be more vocal about encouraging investors to reap some gains and wait for valuations to moderate.

What looks to be shaping into a potential trade for some income-seeking investors is the appearance of a handful of oil-related stocks--

We accomplish 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 this is done, we create two tables, one reflecting the top 10 dividend-yielding stocks of our Ultimate Stock-Pickers, and the other representing stocks that are paying dividends in excess of the S&P 500 that are also widely held by our top managers. In our view, finding stocks that are yielding more than the benchmark index, but which operate in more stable industries, where there is less uncertainty surrounding their future cash flows, should offer some downside protection for investors (which seems to be a growing concern these days). We note that our dividend yield calculations in each of these tables is based on regular dividends that have been declared over the last 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.

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

Company Name

Star Rating

Size of Moat

Current Price (USD)

Price/ FVE

T4Q DVD Yield (%)

Uncertainty Rating

# Funds Holding

# Funds Buying

Philip Morris PM

4

Wide

77.65

0.84

5.1

Low

5

1

ConocoPhil COP

3

None

61.64

0.95

4.7

High

5

1

OxyPetroleum OXY

3

Narrow

72.84

0.97

4

High

7

2

NatOilVarco NOV

4

Narrow

49.07

0.74

3.7

Medium

7

3

GE GE

4

Wide

25.04

0.83

3.6

Medium

8

4

Unilever UL*

2

Wide

42.06

1.11

3.5

Medium

9

4

McDonald's MCD

3

Wide

96.35

0.98

3.4

Medium

5

1

Sanofi SNY*

4

Wide

47.07

0.86

3.4

Medium

6

2

EmersonElec EMR

4

Wide

55.26

0.8

3.3

Medium

7

1

ExxonMobil XOM

4

Wide

83.87

0.86

3.3

Low

8

2

*Dividends for American Depository Receipts (ADRs) can be affected by changes in currency exchange rates. Our calculations also adjust for special dividends. Stock Price and Morningstar Rating data as of 03-13-15.

There have been some changes in the list of top 10 dividend-yielding stocks of our Ultimate Stock-Pickers since

, with

. However, Unilever made our list of top 25 purchases, with General Electric not falling too far off of the expanded list of high-conviction purchases. That said, General Electric was the object of

during the fourth quarter.

Looking more closely at the top 10 widely held securities that meet our criteria for dividend paying stocks, which has traditionally had very little overlap with our list of our Ultimate Stock-Pickers' top 10 dividend-yielding stocks, we see a larger commitment to Consumer Defensive names--

for our Ultimate Stock-Pickers during the last six years.

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

Company Name

Star Rating

Size of Moat

Current Price (USD)

Price/ FVE

T4Q DVD Yield (%)

Uncertainty Rating

# Funds Holding

# Funds Buying

Microsoft MSFT

3

Wide

41.38

0.9

2.9

Medium

15

3

WllsFrgo WFC

3

Narrow

55.34

1.06

2.5

Medium

15

-

P&G PG

4

Wide

81.83

0.91

3.1

Low

13

2

UPS UPS

3

Wide

98.53

1.04

2.8

Medium

12

2

J&J JNJ

3

Wide

99.21

1

2.8

Low

11

-

Wal-Mart WMT

3

Wide

81.9

0.99

2.4

Low

11

3

Intel INTC

3

Wide

30.93

1.07

3

Medium

10

2

Qualcm QCOM

3

Wide

68.64

0.92

2.4

Medium

10

3

U.S. Bancorp USB

4

Narrow

44.29

0.89

2.2

Medium

10

3

Unilever UL*

2

Wide

42.06

1.11

3.5

Medium

9

4

*Dividends for American Depository Receipts (ADRs) can be affected by changes in currency exchange rates. Our calculations also adjust for special dividends. Stock Price and Morningstar Rating data as of 03-13-15.

Valuation is a bigger concern for investors right now, so we thought it best to hone in on the names on both lists that are trading at less than 85% of our analysts' fair value estimates. We believe there might be more value to be had in solid dividend payers offering investors a wider-than-average margin of safety. We've included a few of our observations below:

National Oilwell Varco

Ticker: NOV

Current Yield: 3.7%

Price/Fair Value: 0.74

Morningstar analyst Jason Stevens recently lowered his fair value estimate for National Oilwell Varco to $66 per share from $70, as a result of the change in the Energy team's long-term midcycle oil and gas price assumptions, as well as adjustments to the company's cost of capital assumptions. The biggest knock he has on equipment and services firms like National Oilwell Varco is the expectation for reduced deep-water activity, given the impact that the unconventional oil resource base has had on demand for expensive deep-water projects. This has left the future of National Oilwell Varco's flagship rig system in doubt, as the current excess supply of high-specification deep-water drilling rigs is going to get worse before it gets better. That said, Stevens has higher expectations for the rest of National Oilwell Varco's business, and while revenues are likely to decline over the next five years, he expects the current quarterly dividend to be maintained (but unlikely to be grown until oil prices recover).

Emerson Electric

Ticker: EMR

Current Yield: 3.3%

Price/Fair Value: 0.80

Morningstar reiterated its $69 per share fair value estimate for Emerson Electric following the company's release of fiscal first-quarter results. Our analysts remain impressed with Emerson's ability to generate top-line growth, noting that the strengthening of the U.S. dollar has only made the true rate of growth in all five of Emerson’s operating segments. They believe that this underlying growth, and the firm's ability to mitigate pockets of macroeconomic weakness with its balanced portfolio, both add to the width of its economic moat and provide it with the stability necessary to continue increasing its dividend, currently at $0.47 per share on a quarterly basis. Management's goal is to return at least 50% of the company's annual cash flows to shareholders in the form of dividends or share buybacks, and the firm's dividend has steadily increased each year since the 1950s.

General Electric

Ticker: GE

Current Yield: 3.6%

Price/Fair Value: 0.83

Morningstar analyst Barbara Noverini also covers General Electric, which she notes has been repositioning its business in the last several years, placing a greater emphasis on its wide-moat industrial businesses. Noverini thinks that GE’s core industrial segments still share the common theme of infrastructure development that served as the foundation for its business a century ago, but that powering the "industrial Internet" has come to symbolize the company’s future growth platform. She notes that GE’s resilience in the face of uncertain global macroeconomic conditions further supports her belief that, despite increased concentration on industrials, the portfolio’s end markets and geographic exposure are well diversified. She expects the divided, which was cut to support GE Capital in the aftermath of the 2008-09 financial crisis, to be able to grow from its current base, given the strength and positioning of the company's industrial businesses.

Philip Morris International

Ticker: PM

Current Yield: 5.1%

Price/Fair Value: 0.84

Morningstar analyst Phil Gorham believes that Philip Morris International has one of the strongest businesses in our consumer defensive coverage. The company has 28% global market share (excluding the U.S. and China), making it the largest publicly traded tobacco company in the world, and owns seven of the world's top 15 brands. Its unmatched scale, customer loyalty to the Marlboro brand, and its addictive products give the firm meaningful pricing power, allowing it to produce industry-leading normalized operating margins in the low- to mid-40% range. That said, global consumption is tipping into decline, and packaging rules could threaten the pricing power of premium brands longer-term. This is part of the reason why Gorham expects the firm to spend less on share repurchases and dividend increase than it has since being spun off from

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Disclosure: Greggory Warren own shares of the following securities mentioned above: Altria and Procter & Gamble. 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.