InvestsavvyproBest Dividend Stocks: Investing in dividend stocks can be a lucrative strategy for investors looking to generate a steady stream of income and build long-term wealth. However, choosing the best dividend stocks requires more than just looking at the highest yield.
In this comprehensive guide, we will explore the key factors that investors should consider when selecting dividend stocks, as well as provide a list of undervalued stocks that have the potential to deliver strong returns.
Why Dividend Stocks?
Dividend stocks are companies that distribute a portion of their profits to shareholders in the form of dividends. These stocks are particularly attractive to income-focused investors who want to generate a consistent cash flow from their investments. Dividend stocks can provide a reliable income stream, especially during times of market volatility when other sources of income may be uncertain.
The Pitfalls of Chasing Yield
While high dividend yields may seem appealing, it is important for investors to look beyond the yield and consider other factors that contribute to the overall quality and sustainability of the dividend. Chasing yield alone can lead investors into troubled areas and dividend traps, where companies may have attractive yields that are ultimately unsustainable.
The Importance of Dividend Durability and Reliability
To identify the best dividend stocks, investors should focus on companies with durable dividends and a track record of reliable dividend payments. Dividend durability refers to a company’s ability to maintain its dividend payments over time, even during challenging economic periods. Reliability, on the other hand, relates to a company’s consistent history of paying dividends to shareholders.
When evaluating dividend durability and reliability, investors should consider factors such as the company’s financial stability, cash flow generation, and management’s commitment to dividend payments. Companies with strong balance sheets, stable cash flows, and a history of dividend increases are often more likely to sustain their dividends even in uncertain economic conditions.
Economic Moats and Dividend Durability
Another key factor to consider when selecting dividend stocks is a company’s economic moat. An economic moat refers to a company’s competitive advantage or unique position in the market that makes it difficult for competitors to replicate its success. Morningstar, a leading investment research firm, has found a strong correlation between economic moats and dividend durability.
Companies with wide economic moats have a higher likelihood of maintaining their dividends because they have a sustainable competitive advantage that allows them to generate consistent profits and cash flows. These companies often have strong brands, intellectual property, or cost advantages that provide a barrier to entry for competitors.
Undervalued Dividend Stocks
Investors looking for the best dividend stocks may consider adding undervalued stocks to their portfolios. Undervalued stocks are those that are trading at a price below their intrinsic value, presenting an opportunity for investors to buy them at a discount. Investing in undervalued dividend stocks can offer a potential for capital appreciation in addition to the regular dividend income.
To help investors in their search for undervalued dividend stocks, Morningstar has compiled a list of stocks from its Dividend Yield Focus Index.
These stocks are among the index’s top constituents and have Morningstar Ratings of 4 and 5 stars as of January 15, 2024. Let’s take a closer look at some of these undervalued dividend stocks and their key metrics:
Exxon Mobil (XOM)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Narrow
- Morningstar Uncertainty Rating: High
- Trailing Dividend Yield: 3.68%
- Industry: Oil and Gas Integrated
Exxon Mobil, the oil giant, tops the list of the best dividend stocks to buy. Despite facing challenges in 2020, the company has taken steps to reduce costs and capital spending, which should allow it to meet its dividend payments. Exxon recently raised its dividend by 4%, indicating management’s commitment to shareholder returns. The stock is currently trading at a 20% discount to its estimated fair value.
Verizon Communications (VZ)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Narrow
- Morningstar Uncertainty Rating: Medium
- Trailing Dividend Yield: 6.83%
- Industry: Telecom Services
Verizon is a cheap dividend stock trading 28% below its fair value estimate. While the market has been concerned about the company’s challenges in adding postpaid wireless customers, Morningstar believes that the improving competitive balance in the wireless industry will drive profitability in the future. Verizon’s strong free cash flow generation supports its ability to maintain its high dividend yield.
PepsiCo (PEP)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Low
- Trailing Dividend Yield: 2.96%
- Industry: Beverages—Nonalcoholic
PepsiCo is a dividend aristocrat and a leading player in the nonalcoholic beverage industry. The company has a strong track record of innovation, efficient operations, and flexible distribution channels. With a wide economic moat and a history of dividend increases, PepsiCo is well-positioned to deliver long-term growth and income for investors. The stock is currently trading below its estimated fair value.
Altria Group (MO)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Medium
- Trailing Dividend Yield: 9.29%
- Industry: Tobacco
Altria Group, the highest-yielding stock on the list, is trading at a 21% discount to its fair value estimate. The company, a leading tobacco maker in the United States, is pursuing various strategies to address the decline in cigarette volumes. Altria’s ability to consistently price above volume declines and its focus on dividends as a capital-allocation priority make it an attractive dividend stock.
Wells Fargo (WFC)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Medium
- Trailing Dividend Yield: 2.74%
- Industry: Banks—Diversified
Wells Fargo is the only bank on the list of cheap dividend stocks, trading 11% below its fair value estimate. While the bank has faced challenges in recent years, its sound balance sheet and multi-year rebuild plan position it for future success. Wells Fargo’s dividend payout ratio is expected to return to normal levels, providing potential for dividend growth.
Comcast (CMCSA)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Medium
- Trailing Dividend Yield: 2.70%
- Industry: Telecom Services
Comcast, a leading telecommunications company, is trading at a 28% discount to its estimated fair value. Despite a slight customer loss in the third quarter, Comcast has strong pricing power and is well-positioned to limit broadband share losses. The company has a solid balance sheet and a history of dividend increases, making it an attractive option for income-focused investors.
Bristol-Myers Squibb (BMY)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Medium
- Trailing Dividend Yield: 4.59%
- Industry: Drug Manufacturers—General
Bristol-Myers Squibb, a leading drug manufacturer, is trading 20% below its fair value estimate. The company has built a strong portfolio of drugs and has a robust pipeline, supported by strategic acquisitions. While its payout ratio is below the industry average, Bristol-Myers Squibb’s dividend is expected to increase over the next five years as upcoming patent losses drive the payout ratio closer to average.
Gilead Sciences (GILD)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Medium
- Trailing Dividend Yield: 3.47%
- Industry: Drug Manufacturers—General
Gilead Sciences is trading 13% below its fair value estimate, presenting an opportunity for investors. The company’s HIV and HCV portfolio generates outstanding profit margins, and its strong pipeline supports a wide economic moat rating. With a reasonable payout ratio and steady dividend increases, Gilead Sciences offers a compelling investment opportunity in the pharmaceutical sector.
Medtronic (MDT)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Medium
- Trailing Dividend Yield: 3.15%
- Industry: Medical Devices
Medtronic, the largest pure-play medical device maker, is trading 22% below its fair value estimate. The company’s diversified product portfolio and partnerships with hospitals position it well in the healthcare industry. Medtronic’s commitment to dividend growth, supported by a strong balance sheet, makes it an appealing choice for dividend-focused investors.
NextEra Energy (NEE)
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: Narrow
- Trailing Dividend Yield: 3.06%
- Industry: Utilities—Regulated Electric
NextEra Energy, a narrow-moat company, is a dividend aristocrat known for its regulated utility and fast-growing renewable energy business. The company’s secure dividend and growth potential make it an attractive option for investors seeking both income and capital appreciation. NextEra Energy is trading at a 16% discount to its estimated fair value.
The Morningstar Dividend Yield Focus Index
The Morningstar Dividend Yield Focus Index is a subset of the Morningstar US Market Index, representing 97% of equity market capitalization. This index tracks the top 75 high-yielding stocks that meet Morningstar’s screening requirements for quality and financial health.
To be included in the index, companies must have qualified income dividends, a narrow or wide economic moat rating, and a low, medium, or high uncertainty rating. Companies with very high or extreme uncertainty ratings are excluded. The index also considers financial health using a measure of balance-sheet strength.
The 75 highest-yielding stocks that pass the quality screen are included in the index and weighted based on the total dividends paid by the company to investors.
Finding the Best Dividend Stocks
Investors who want to uncover more cheap dividend stocks can utilize various resources and tools. Morningstar offers a full list of dividend stocks included in the Dividend Yield Focus Index, with those having 4 or 5-star ratings considered undervalued. Additionally, the Morningstar Investor Screener tool allows investors to search for dividend stocks based on specific criteria such as dividend yield and valuation measures.
For ongoing monitoring and tracking of dividend stocks, investors can use Morningstar Investor to build a watchlist and create a customized view of valuations, ratings, and dividend yields. Morningstar also provides a video series hosted by David Harrell, offering additional ideas and insights on dividend stocks.
FAQs on Best Dividend Stocks
What are dividend stocks?
Dividend stocks are shares of companies that regularly distribute a portion of their earnings to shareholders in the form of dividends. These payments are often made quarterly and provide investors with a source of income.
Why should I consider investing in dividend stocks?
Investing in dividend stocks can provide a steady stream of income, making them attractive to income-seeking investors. Additionally, companies that consistently pay dividends may indicate financial stability and a history of profitability.
How are dividend yields calculated?
Dividend yield is calculated by taking the annual dividend payment per share and dividing it by the stock’s current market price. It’s expressed as a percentage.
What factors should I consider when evaluating dividend stocks?
Key factors include the company’s financial health, dividend history, payout ratio (the percentage of earnings paid as dividends), industry trends, and potential for future growth. Stable and growing companies with a history of dividend increases are often preferred.
Are high dividend yields always better?
Not necessarily. A high dividend yield can be a sign of an attractive investment, but it’s crucial to consider the sustainability of the dividend. A very high yield might be a result of a declining stock price or an unsustainable payout ratio.
What is a dividend aristocrat?
A dividend aristocrat is a company that has consistently increased its dividend for a specific number of consecutive years. These companies often have a strong track record of financial stability and performance.
Can dividend payments be reinvested?
Yes, many companies offer dividend reinvestment plans (DRIPs) that allow investors to automatically reinvest their dividend payments to purchase additional shares of the stock.
Are there risks associated with investing in dividend stocks?
Yes, like any investment, dividend stocks come with risks. Economic downturns, changes in interest rates, and industry-specific challenges can impact a company’s ability to pay dividends.
How do taxes work with dividend income?
Dividend income is generally taxable. The tax treatment depends on factors such as your country of residence and the type of account in which you hold the stocks (taxable account vs. tax-advantaged account).
Where can I find information about the best dividend stocks?
Financial news websites, stock brokerage platforms, and reputable financial publications often provide lists and analyses of top dividend stocks. Additionally, conducting thorough research on individual companies is essential.
In conclusion, investing in the best dividend stocks can provide investors with a reliable income stream and potential for long-term growth. By considering factors such as dividend durability, economic moats, and undervalued opportunities, investors can build a portfolio of dividend stocks that meet their income and investment objectives. Conducting thorough research and utilizing tools like Morningstar can help investors identify the most promising dividend stocks for their investment strategy.
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