Four dividend diamonds for dependable returns

With a consistent bond-like flow of income, these stocks present attractive options.

Vikram Barhat 21 December, 2016 | 6:00PM
Facebook Twitter LinkedIn

As yet another volatile year draws to a close, investors are looking to rebalance their portfolios for a new year and the challenges and opportunities it may bring. For those looking for stability and predictability of income, this may be a good time to scour for quality dividend payers with steady cash flow and some potential for price appreciation.

With a consistent bond-like flow of income, these stocks present attractive options to consider when capital allocations are rejigged. The returns of dividend-paying stocks tend to be less volatile and more predictable, says Morningstar's Karen Wallace.

"When more of the total return comes from dividend payments, investors don't need to rely as much on price appreciation to get a reasonable return," Wallace wrote in a recent article published on Morningstar.com. Although, a dram of capital growth along the way won't hurt either.

Top-yielding stocks in Morningstar's U.S. equity coverage universe offer dividend payouts that are considerably higher than the 2.3% generated by the S&P 500, as of Dec. 7. Further, some of these stocks are trading below their fair value, offering a margin of safety and potential for future price appreciation.

With conservative balance sheets and a sharp focus on cash generation, these companies also have robust businesses that are built to withstand even severe market conditions.

Compass Minerals International Inc.
Ticker CMP
Current yield 3.49%
Forward P/E 23.0
Price $79.75
Fair value $89
Data as of Dec. 19, 2016

 Compass Minerals (CMP) primarily produces de-icing salt and sulfate of potash in North America and the United Kingdom. Compass' salt products are used by state, provincial and municipal highway departments, as well as industrial and consumer end markets. The company currently offers a solid 3.5% dividend yield.

The company's envious portfolio contains an array of cost-advantaged assets. "Its rock salt mine in Ontario benefits from unique geology, and with access to a deep-water port, can deliver de-icing salt to customers at low cost," says a Morningstar report.

Salt is the most economical solution to snowy and icy roadways during winter. With mines close to waterways like the Great Lakes and Mississippi River, Compass can competitively deliver de-icing salt to local governments and municipalities, says Morningstar equity analyst, Jeffrey Stafford.

Compass' sustainable competitive advantage, or wide economic moat, is built on unique assets that are difficult, if not impossible, to replicate. The firm's cost advantage over other producers extends to the production of sulphate of potash (SOP), used by growers of high-value crops. "The company controls one of only three naturally occurring brine sources that produces SOP, a specialty fertilizer priced at a premium to standard potash," says Stafford, who appraises the stock's value to be US$89.

Using naturally occurring salt brines to make SOP costs 40% to 50% less than other processes. These cost advantages have led to strong returns on invested capital, which Stafford says will continue to "outpace the costs of capital for the next 20 years."

GlaxoSmithKline PLC ADR
Ticker GSK
Current yield 5.45%
Forward P/E 15.2
Price $38.31
Fair value $47
Data as of Dec. 19, 2016

One of the largest pharmaceutical companies by market capitalization,  GlaxoSmithKline (GSK) dominates the market across multiple therapeutic classes, including respiratory and antiviral, as well as vaccines and healthcare-related consumer products.

The company's strong competitive advantage is built on innovative new products and expansive list of patent-protected drugs that carry strong pricing power. "The magnitude of the company's reach is evidenced by a product portfolio that spans several therapeutic classes, as well as vaccines and consumer goods," says a Morningstar report. "The diverse platform insulates the company from problems with any single product."

Glaxo has shifted away from past strategies of slight enhancements in favour of true innovation. "The benefits of this strategy are showing up in Glaxo's early-stage drugs [that promise to] improve both approval rates and pricing power," says Morningstar sector director, Damien Conover, who recently upped the stock's fair value estimate to US$47 from US$46, prompted by, among other things, operating efficiency improvements and increased margin expectations. Since 2012, the company has identified over GBP 3 billion in potential annual cost savings, which should be achieved by 2016.

The drugmaker is strategically expanding its footprint to fast-growing emerging markets which "will help support long-term growth and diversify cash flows beyond developed markets," says Conover, who forecasts average annual sales growth of 5% during the next decade, with new products offsetting patent losses.

Glaxo has a 5.54% dividend yield and has consistently created value for its shareholders over the years.

Procter & Gamble Co.
Ticker PG
Current yield 3.15%
Forward P/E 19.9
Price $84.71
Fair value $92
Data as of Dec. 19, 2016

The world's largest consumer products manufacturer,  Procter & Gamble Co. (PG) owns many non-food brands consumed by millions around the globe. Its portfolio of household and personal-care products includes such familiar names as Tide, Charmin, Pantene and Pampers. The business generates 60% of its total sales outside the United States, a third of which from emerging markets.

P&G has grown more nimble since its decision to shed around 100 brands -- more than half of its portfolio. Additionally, it's looking to realize US$10 billion in savings by trimming overhead, lowering material costs and increasing manufacturing and marketing productivity. "P&G's recent strategic actions indicate it is parting ways with its former self to become a more nimble and responsive player in the global consumer products arena," says Morningstar sector head, Erin Lash, who estimates the stock is worth US$92, and recommends "investors interested in the household and personal-care space consider taking a stake in this wide-moat name."

P&G's main competitive advantages include its significant clout with retailers, as well as its substantial cost advantage inherent in its size and scale. Lash projects the firm to continue to out-earn its cost of capital over the next 20 years, with its sales growing at 4% annually, and operating margins expanding to more than 24% by 2026 from 21% in 2016. "The firm has growth opportunities for its brands in many overseas markets, and in developed markets it remains the share leader in many of its categories," she adds.

With a 3.15% yield, PG is a solid stock for investors who like to collect quarterly dividend cheques.

Daimler AG
Ticker DDAIF
Current yield 5.03%
Forward P/E 8.1
Price $73.43
Fair value $87
Data as of Dec. 19, 2016

The maker of Mercedes-Benz and Smart Car,  Daimler (DDAIF) is a leading automobiles manufacturer with global reach. The German carmaker also builds commercial trucks, vans and buses, and owns a 3.1% stake each in Renault and Nissan, and 15% of Russian truckmaker Kamaz.

"Geographically diverse sales reduce exposure to the economic conditions of any one region," says a Morningstar report. "Even so, premium brands such as Mercedes limit carmakers' exposure to downturns suffered by mass-market auto companies because wealthier customers still have the funds to buy a vehicle during a recession."

As one of the top luxury automobile names in the world, Mercedes-Benz provides the company a modest cushion against the cyclical downturns of auto sales. The company introduces new or significantly refreshed Benz models in various global markets every year, which is critical to igniting consumer interest and helps the bottom line even in an economic downturn, says Morningstar equity analyst Richard Hilgert.

While Daimler operates in a fiercely competitive, highly cyclical, capital-intensive industry, "over the long term, Daimler has the potential to be one of the most profitable automakers around,” says Hilgert, who recently raised his fair value estimate on Daimler's American depositary receipts (ADRs) from US$82 to US$87.

He adds: "Management's returns on sales targets are higher than what we model, so upside potential exists to our valuation." The stock's healthy dividend yield of over 5% handily surpasses that of the S&P 500 (2.3%) and the industry average (2.8%).

Complete access to Morningstar's research on equities, mutual funds and exchange-traded funds is available to subscribers to Morningstar Canada Premium.

Facebook Twitter LinkedIn

About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

© Copyright 2022 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy