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Market Update

6 Stocks Top Dividend Managers Have Been Buying

Managers from American Century, ClearBridge, and Blackrock have picked up energy stocks, IT plays, and an underappreciated retailer.

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Stock ideas can come from a lot of different places--financial news programs and websites, newspapers, our neighbors. Some of those ideas are worth investigating further; others, not so much. It all depends on the quality of the source.

Occasionally on, we take a look at some of the stocks our Medalist Managers bought during the previous quarter. After all, Morningstar knows who the good money managers in the fund industry are, and we think these managers qualify as high-qualilty sources of stock ideas. So it's only natural that we peek into the portfolios of some of the best, reveal their recent purchases, and then share what our equity analysts think of these ideas today.

This installment focuses on managers investing in dividend-paying stocks.

Veteran manager Phil Davison and his team at American Century Equity Income (TWEIX), which earns a Silver Morningstar Analyst Rating, emphasize high-quality dividend payers boasting high returns on capital, stable revenue, and low leverage. Energy is currently a dominant sector in the portfolio.

"We look for attractively valued, higher-quality companies, including integrated oil companies with strong balance sheets and sustainable dividends," noted the team in its latest commentary. "Temporary weakness in Schlumberger's (SLB) stock during the quarter allows us the opportunity to increase our position in the leading oilfield services company." The team also picked up Royal Dutch Shell (RDS.A) (RDS.B) in the third quarter. "The company is benefiting from stronger oil prices, and the management team has refocused the company on returns on capital versus growth."

Schlumberger currently earns a narrow economic moat rating from Morningstar and trades in 3-star range as of this writing, suggesting its shares are fairly valued relative to our fair value estimate.

"Among oilfield services companies, Schlumberger has long stood in a class of its own," writes Morningstar analyst Preston Caldwell in his latest report. The company has earned solid economic profits for decades, he says, and is likely to continue to do so going forward. Notably, Schlumberger has been able to develop and sell differentiated products and services--often new or novel variations on older technologies. That "limits competition and ensures high margins and returns on capital," says Caldwell.

Shell, meanwhile, is on a path to boost margins and improve returns by 2020, says Morningstar sector strategist Allen Good in his latest company report.

"Like the rest of the integrated group, Shell is working to reduce its cost base, which has become bloated during the past five years, by reducing head count and improving its supply chain," says Good. "The integration of BG is integral to Shell's efforts, as it holds the potential for $4.5 billion of cost-reduction synergies. Furthermore, the addition of BG's low-cost production reduces Shell's per-barrel operating cost, which ranked among the highest in its peer group." Operating costs are down by 20% since 2014. Shell's A shares trade in 4-star range, suggesting they're undervalued; the B shares are fairly valued at 3 stars. (Shell's Class B shares typically trade at a premium to its Class A shares due to the former's simplified tax proposition.)

Davison and his team also favor the information technology sector today.

"The sector benefits from business automation trends, technology upgrades, and the rapid growth of cloud infrastructure. We particularly favor stocks in the semiconductors and semiconductor equipment industry as the industry is benefiting from strong demand and has become less volatile through consolidation." Specifically, the team added to its position in Oracle (ORCL) during the third quarter, when the stock fell due lower-than-expected guidance on its cloud services business.

"Oracle is at a crossroads, in our view," writes Morningstar senior equity analyst Rodney Nelson in his latest analysis. "The rise of cloud computing and open-source software over the past two decades has caught the software giant somewhat flat-footed, leaving the firm in scramble mode as it races its peers to the cloud. While many of its products are under siege, we think the firm can maintain its status near the top of the software food chain."

Oracle continues to earn a wide economic moat rating from Morningstar, thanks to its application and infrastructure software business. 

"Oracle's presence in the database market remains unmatched," says Nelson. Shares are fairly valued as of this writing, trading in 3-star range.

The team at Bronze-rated ClearBridge Dividend Strategy (SOPAX) likes high-quality large companies with solid pricing power, low risk of product/service obsolescence, and strong returns on invested capital; they dislike deep cyclicals and companies with tough-to-grasp businesses. Among other names, the team picked up Kinder Morgan (KMI) in the third quarter. The team explained in its latest commentary that it bought the midstream energy company when it traded weakly along with other energy names.

"Kinder Morgan spans the continent, transporting a significant fraction of the nation's crude oil, refined products, and natural gas, and is involved in virtually every link of the midstream energy value chain," notes Morningstar sector strategist Travis Miller in his latest company report. Kinder's size is simultaneously an opportunity and a challenge, says Miller. Its size gives it plenty of options for expansion.

"However, it must invest $3 billion-$4 billion in value-enhancing projects each year to maintain a growth rate in line with smaller pipeline owners," writes Miller. "As the great shale infrastructure boom has slowed, it has been more difficult for Kinder to maintain its dividend growth, hence the dividend reduction that occurred in late 2015." Shares are currently trading in 3-star range, suggesting they’re fairly valued by Morningstar's metrics.

Manager Tony DeSpirito and his team at Bronze-rated BlackRock Equity Dividend (MADVX) look for attractively priced companies offering consistent dividend growth, competitive yields, and strong financial and business models. During the third quarter, they swapped Home Depot (HD) for Lowe's (LOW).

"We exited our position in Home Depot and used the proceeds to initiate a position in Lowe's due to the relative valuation gap between the two stocks," they noted in their recent commentary.

In her latest report, Morningstar senior equity analyst Jaime Katz says that the second-largest home-improvement retailer in the world is a solid operator.

"Its scale enables consolidated purchasing power, leading to a low-cost position, while an automated distribution network puts vendors, distribution centers, and stores on one IT platform, driving operational efficiency," says Katz. The company earns a wide economic moat rating, thanks to its scale and its information technology platform and distribution network, which Katz notes are key differentiators in the retail sector. The company has delivered average returns on invested capital of 13% over the past five years.

"In our opinion, the specialized nature of Lowe's offerings provides some protection from mass merchants and large online retailers, who would find it difficult to capture better pricing with vendors or afford the shipping costs of some items," concludes Katz. Shares are currently undervalued, trading in 4-star territory.

DeSpirito and company also bought CDW (CDW) in the third quarter.

"CDW is the largest value added reseller of information technology in North America. We believe CDW's core business has underappreciated earnings power due to its attractive returns on capital, strong free cash flow generation and opportunity for a long growth path via market share gains."

Morningstar analysts don't formally cover CDW, but according to Morningstar's quantitative models, shares are overvalued today.  

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