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16 Stocks Added to the Dividend Yield Focus Index

These high-quality dividend payers are the newest entrants to the index, and we take a closer look at three that are undervalued today.

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In March, we made some changes to the Morningstar Dividend Yield Focus Index. 

Our Dividend Yield Focus strategy looks at both backward-looking and qualitative forward-looking measures to find high-yielding stocks that are financially healthy enough to sustain their dividend.

We first screen the Morningstar US Market Index for dividend-payers. (The dividend must come from qualified income, so real estate investment trusts are not included.) We then apply the quality screens: We search the high-yielders for companies that have Morningstar Economic Moat Ratings of wide or narrow, meaning that we think they have competitive advantages that will allow them to continue to earn above-average profits and sustain their dividends for 20 or 10 years, respectively. We also consider a company's Morningstar distance to default ratio, a metric that uses market information and accounting data to determine how likely a firm is to default on its liabilities.

The 75 highest-yielding stocks that make it through the quality screen are then included in the index. The index is dividend dollar-weighted (constituents are weighted according to the total dividends paid by the company to investors). Click here to see the current holdings.

New Dividend-Payers in the Index
In the table below, we show the newest entrants to the Dividend Yield Focus Index, which pass our strict requirements for high yields, sustainable competitive advantages, and financial health. (Note that the dividend yields listed below are backward-looking and could change.) 

We added 16 stocks to the index during the latest reconstitution instead of the usual 15 because index holding Spectra Energy stopped trading in late February when it was acquired by  Enbridge (ENB).

Three stocks look cheap relative to our analysts' estimate of intrinsic value.

 Marathon Petroleum (MPC)
While its existing refining asset base is well positioned to capitalize on the ever-changing domestic crude market, Marathon Petroleum is investing to expand its midstream and retail businesses in an effort to diversify its earnings stream away from the more volatile refining business, says energy sector strategist Allen Good. Though capital will increasingly be directed toward midstream and retail projects, Marathon is still investing to improve its competitive position and profitability. Currently able to export about 250 mb/d (thousands of barrels a day), Good says narrow-moat Marathon is investing to increase that capacity to 500 mb/d by 2019. Further, the firm's sole exposure to the midcontinent and Gulf Coast results in greater profitability, in Good's view, and leaves it better positioned to capitalize on differentials compared with more geographically diversified peers.

 VF Corp (VFC)
Wide-moat VF Corp owns a large portfolio of brands including The North Face, Timberland, Vans, Lee, Wrangler, and Nautica. Analyst Bridget Weishaar is optimistic about VF Corp's prospects because she thinks the company is poised to take advantage of three market trends. First, she believes the outdoor and action sports market is a large and quickly growing opportunity, with activewear apparel now often worn in place of casual attire. Second, she expects VF to leverage its large global supply chain to support additional international sales; she thinks international markets can grow from 38% of revenue (2016) to just under 45% of sales in five years. Finally, Weishaar sees direct-to-consumer sales growing to 30% of sales from the current 28% penetration (2016), with e-commerce being the fastest growing, most profitable channel.

 New York Community Bancorp (NYCB)
Narrow-moat NYCB's core strength is its expertise in the New York multifamily lending market, which was compiled through a series of acquisitions of New York-based thrifts from 2000 to 2007. Through eight acquisitions during that period, NYCB is now the leading producer of multifamily loans for investment in New York City, says financial services sector director Stephen Ellis. Moreover, the bank is one of the most efficient operators under our coverage, in his opinion. Ellis explains, however, that if NYCB cannot find a bank to acquire in 2017, it may cross over the $50 billion mark organically in 2018, likely becoming a systemically important financial institution, or SIFI, in 2019. Investors should note that this may result in a dividend cut in line with the SIFI transition to around a 30% payout ratio. (The stock's trailing 12-month dividend yield is currently 4.87% with a payout ratio of 0.67%.)

Stocks Removed from the Index
On the flip side, 15 companies were removed from the index. 

 Occidental Petroleum (OXY), was removed because we downgraded its moat rating to none from narrow. Senior equity analyst David Meats notes that OXY is a top producer in the Permian basin, and it has a good-size unconventional business as well. Though the unconventional business could potentially justify an economic moat on a stand-alone basis, Meats says his forecasts for midcycle returns on invested capital aren't currently high enough to justify a narrow moat rating for the company. 

Three companies,  Yum Brands (YUM),  Carnival Corp (CCL), and  KLA-Tencor (KLAC), were removed from the index because their dividends were no longer among the 75 highest-yielding quality firms (as measured by economic moat and distance to default).

Many more these companies were removed because the company's distance to default ratio crept into a range that we weren't comfortable with.

Distance to default is another other safety-oriented metric that we use to build the index. True to its name, it's focused on financial health. Distance to default uses option-pricing theory to measure whether a firm is falling into financial distress. It's gauging whether the value of a company's assets will fall below the sum of its liabilities. If a company is in distress, the dividend is at risk and there's trouble ahead. So, like moat, distance to default is another important screen for this index. (To read more about distance to default, click here.)

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