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5 High-Quality, High-Yielding Stocks

We expect these high-yielders to sustain their dividends in the future. Plus, they’re cheap.

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Earlier this week, we looked at the top 10 dividend-yielding stocks among our Ultimate Stock Pickers, a collection of managers whose stock-picking prowess we admire. What talented managers own--and are buying--can be a terrific source of investment ideas to research further.

Today, we’re looking for opportunities among dividend-paying stocks from another angle--from the holdings in the Morningstar Dividend Yield Focus Index. A subset of the Morningstar US Market Index (which represents 97% of equity market capitalization), this index tracks the top 75 high-yielding stocks that meet our screening requirements for quality and financial health.

How are the index constituents chosen? For starters, only securities whose dividends are qualified income are included; real estate investment trusts are tossed out. Companies are then screened for quality using the Morningstar Economic Moat and Uncertainty ratings. Specifically, companies must earn a moat rating of narrow or wide and an uncertainty rating of low, medium, or high; companies with very high or extreme uncertainty ratings are excluded. We then screen for financial health using our distance to default measure, which uses market information and accounting data to determine how likely a firm is to default on its liabilities; it is a measure of balance-sheet strength. The 75 highest-yielding stocks that pass the quality screen are included in the index, and constituents are weighted according to the total dividends paid by the company to investors.

Here are the index’s top 10 holdings today. Half are trading in 4-star range as of this writing, suggesting that they’re undervalued by our metrics.

Here’s a little bit from our analysts about the strength of the moats--and therefore the quality--for three of the inexpensive names.

Coca-Cola (KO)
“As the one of the largest beverage companies in the world, Coca-Cola has earned a wide economic moat, thanks to its brand intangible assets and cost advantages created by its strong relationships with retailers and economies of scale. Coca-Cola maintains a leading share of the global sparkling soft drink category, and the firm’s portfolio includes 21 brands that generate over $1 billion in revenue each year, leading to extremely strong relationships with distributors and retailers that depend on leading brands to drive store traffic. According to Beverage Digest, the firm holds a 29% volume share of the U.S. nonalcoholic beverage market, including a 43% share of the carbonated soft drink category. In our opinion, the firm will be able to maintain these relationships over the long run given the resources it has to reinvest in its brands. Coca-Cola has also historically been a price leader in the nonalcoholic beverage category, which we consider further evidence of its wide moat.

"In our opinion, Coca-Colas’ brand-driven intangible assets and economies of scale will drive economic returns well above its cost of capital over the long run. We forecast adjusted returns on invested capital, excluding goodwill, to average around 20% over the next five years (well above our 7% weighted average cost of capital estimate), bolstering our conviction that the firm possesses a wide economic moat.”
--Sonia Vora, analyst

Exxon Mobil (XOM)
“We continue to rate Exxon as the highest-quality integrated firm, given its ability to capture economic rents along the oil and gas value chain. While its peers operate a similar business model with the same goal, they fail to do so as successfully, as evidenced in the lower margins and returns compared with Exxon. Exxon generates its superior returns from the integration of low-cost assets (an intangible asset that we consider to be part of its moat source) combined with a low cost of capital; this combination produces excess returns greater than those of its peers. However, given our outlook for lower long-term oil and natural gas prices, we expect Exxon's returns to be lower than they have been in the past. Additionally, its decision to increase investment relative to peers during the next five years is also likely to narrow the gap in returns with peers. Consequently, our confidence that it can continue to deliver excess returns for longer is diminished, resulting in the company no longer earning a wide moat. We now rate Exxon with a narrow moat.

"The size and physical integration between Exxon’s refining and chemical manufacturing is a unique asset that creates an unequaled advantage that cannot realistically be duplicated. Approximately 80% of its refining capacity is integrated with chemical-manufacturing facilities. The integrated network delivers wider margins and returns than peers, thanks to a low-cost position derived from economies of scale and the ability to process a variety of feedstocks into the highest-value products. As a result, Exxon's downstream averaged returns on capital employed have historically far outpaced the group average.”
--Allen Good, sector strategist

 Pfizer (PFE)
“Patents, economies of scale, and a powerful distribution network support Pfizer’s wide moat. Pfizer’s patent-protected drugs carry strong pricing power that enables the firm to generate returns on invested capital in excess of its cost of capital. Further, the patents give the company time to develop the next generation of drugs before generic competition arises. Additionally, while Pfizer holds a diversified product portfolio, there is some product concentration, with the company’s largest product Prevnar representing just over 10% of total sales. However, we don't expect typical generic competition for the vaccine due to complex manufacturing and relatively low prices for the product. Further, we expect new products will mitigate the eventual generic competition of other key drugs.

"Also, Pfizer’s operating structure allows for cost-cutting following patent losses to reduce the margin pressure from lost high-margin drug sales. Overall, Pfizer’s established product line creates the enormous cash flows needed to fund the average $800 million in development costs per new drug. In addition, the company's powerful distribution network sets up the company as a strong partner for smaller drug companies that lack Pfizer’s resources.

"Pfizer’s entrenched consumer and vaccine franchises create an added layer of competitive advantage, stemming from brand power in consumer healthcare and manufacturing cost advantages in the vaccines division. Pfizer is considering selling its consumer healthcare group, but the potential divestment shouldn't have a material impact on the company's moat.”
--Damien Conover, sector director

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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.