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10 Cheap Stocks With Growing Dividends

The Morningstar US Dividend Growth Index homes in on cash-rich businesses with sustainable and growing yields.

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My colleague Christine Benz once explored the question, should you manage your portfolio for income or total return? Her conclusion: Who says you have to choose? Savvy dividend investors have known this all along; investing in high-quality dividend-payers allows you to get the best of both worlds. 

But the key here is "quality." sometimes the highest yields portend danger. Those juicy dividends are likely to be cut, particularly if the payout constitutes a large percentage of earnings. That leaves only a small buffer to sustain those payments if earnings fall. (A stock's payout ratio can help you get a handle on this.) 

Rather than homing in on the market's juiciest yields, the Morningstar US Dividend Growth Index looks for companies whose cash flows have translated into a rising payout. Companies that are focused on growing dividends tend to be higher quality, cash-rich businesses that hold up well in down markets, participate in up markets, and are capable of excess returns over a full market cycle. 

Though they're not the highest-yielding strategies in absolute terms, dividend-growth strategies like the US Dividend Growth Index are great ways to target stocks that have the potential for dividend growth and capital appreciation.

Every December, we make sure the index's current constituents still meet our strict criteria, and we add any new, carefully vetted stocks that pass the screens. As a result, the overall number of stocks in the index is subject to the selection and eligibility criteria at the time of reconstitution. There are currently more than 450 holdings. Each subsequent quarter, we rebalance the index, but the constituents stay the same.

To qualify for inclusion in the strategy, a stock must meet the following criteria (in sequence). First we cull the U.S. equity market for securities that pay qualified dividends. (This excludes real estate investment trusts.) Index constituents must exhibit a five-year history of increasing their dividend payments. To gauge the sustainability of dividend growth into the future, eligible constituents must display positive consensus earnings forecasts from the analyst community. As a safeguard against dividend cuts and financial distress, stocks with indicated dividend yield in the top 10% of the universe are excluded. Finally, existing constituents are allowed to remain if they have recently bought back shares and have not decreased their dividend payment.

To screen out dividends that may be unsustainable, we also exclude companies with payout ratios above 75%.

Below are the 10 cheapest stocks in the index, ranked by price/fair value.

Disclosure: Morningstar, Inc. licenses indexes to financial institutions as the tracking indexes for investable products, such as exchange-traded funds, sponsored by the financial institution. The license fee for such use is paid by the sponsoring financial institution based mainly on the total assets of the investable product. Please click here for a list of investable products that track or have tracked a Morningstar index. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representations regarding the advisability of investing in any investable product that tracks a Morningstar index.

Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.