By Serkan Unal
Morningstar, a fund research company, uses a proprietary model to construct a special dividend index, Morningstar® US Dividend Target 50 Index. The 50 index constituents are not only ranked by their yields but also according to a combination of factors that reflect the companies' underlying quality and growth potential. The index includes 50 companies that have the highest scores based on a combination of factors, including dividend yield (33.3% of the score), cash-flow-to-debt ratio (20%), return on equity in the latest quarter (20%), five-year EPS growth (13.3%) and consensus EPS estimate revisions over the past 90 days (13.3%).
An ETF that tracks the index is Canada-listed First Asset Morningstar US Dividend Target 50 Index ETF (UXM.TO), which has an expense ratio of 0.60% and a dividend yield of 4.7%. Its 1-year total return is 9.03%, below the S&P 500's 16.0%, and the 10-year total return is 9.6%, above 6.4% for the S&P 500. Here is a closer look at the index's top five dividend stocks.
Marathon Oil Corporation (NYSE:MRO), a global energy company, is the top holding in Morningstar's index. Its dividend yield of 2.1% is lower than industry's 3.3%. The company has a cash-flow-to-debt ratio of 0.85, based on operating cash flow and long-term debt. Its ROE based on trailing-twelve-months is 10.4%, above its industry's 7.7%. The company's annual EPS growth averaged negative 19% over the past five years, but is expected to rebound to an average of 5.0% per year for the next five years. Consensus 2013 EPS estimate revision is negative 4.7% over the past 90 days. The company expects oil output, driven by the U.S. oil shale production, to be up 6% to 8% this year, and to grow, on average, by between 5% and 7% annually through 2017. The stock is priced at 11.9x trailing and 10.3x forward earnings. Its price-to-book of 1.3 is higher than the five-year average, but is still below the industry average of 1.5. Last quarter, billionaire Ken Griffin trimmed his MRO position by 32% to $120 million, while another billionaire, Steven Cohen, hiked his stake by 197% to $87 million.
Federated Investors (NYSE:FII), an asset manager, is the second largest holding in Morningstar's index. Its dividend yield of 4.4% is well above the industry average of 2.1%. The company's cash-flow-to-debt ratio is 0.73, based on operating cash flow and long-term debt. Its trailing-twelve-month ROE is 29.5%, more than 3 times larger than the industry average of 9.4%. The company's annual EPS growth averaged negative 4.2% over the past five years, but is expected to rebound to an annual average of 6.5% for the next five years. Consensus 2013 EPS estimate revision is positive 0.6% over the past 90 days. The long awaited reform of the money market funds which constitute 40% of Federated revenues has been pushed out, which is a positive for the stock. However, despite the favorable climate for asset managers and given the momentum that has taken the stock up more than 28% over the past year, FII may not have much more room for P/E expansion. Analysts are generally downbeat. The stock is currently trading at 12.8x forward earnings, below industry multiple of 15.3x. The stock's price-to-book is higher than the industry average, but is still lower than the stock's five-year average. At the end of last quarter, value investor Chuck Royce owned more than $266 million in FII stock.
International Flavors & Fragrances (NYSE:IFF), one of the largest manufacturers of flavors and fragrance chemicals, is the Morningstar index's third largest holding. It pays a dividend yield of 2.0%, which is slightly higher than the industry average yield of 1.6%. The company has a cash-flow-to-debt ratio of 0.32, based on operating cash flow and long-term debt. Its trailing-twelve-month ROE is 17.1%, more than 3 times larger than the industry average of 5.5%. The company's EPS grew, on average, by 5.6% annually over the past five years. Its EPS growth is expected to average 6.8% annually for the next five years. Consensus 2013 EPS estimate revision is positive 1.4% over the past 90 days. This company is well positioned for growth in emerging markets, from which it derives 47% of total revenues. Last month, the company's Board of Directors approved a $250 million stock buyback plan which will be implemented as of the first quarter of 2013. The stock is valued below industry at 17.7x trailing and 15.9x forward earnings. Still, its price-to-book is 36% higher than the industry average ratio. Last quarter, fund managers D. E. Shaw, Chuck Royce, and Israel Englander held positions in the stock.
H&R Block (NYSE:HRB), a provider of tax preparation and related services, is the fourth largest holding in Morningstar's index. Its dividend yield is 4.0%, which is nearly 200 basis points higher than its industry's average yield. The company's cash-flow-to-debt ratio is 0.42, based on operating cash flow and long-term debt. HRB's trailing-twelve-month ROE is 49.0%, almost 5 times larger than the industry average of 10.4%. The company's annual EPS growth averaged 0.4% over the past five years, and is expected to average 11.0% per year for the next five years. Consensus fiscal 2013 EPS estimate revision is positive 1.2% over the past 90 days. The company holds a large hoard of cash, worth 32% of its total assets, but its free cash flow position has deteriorated. As reported by Dividend.com, Compass Point downgraded the stock last month, saying that despite the company's earnings growth over the next few years, the "risk/reward is balanced at the current level," with trailing P/E of 15x. The stock trades at a forward P/E of 12.8x, but its price-to-book is well above industry and the stock's own five-year averages. Last quarter, Viking Global's Andreas Halvorsen held $411 million in the stock.
Southern Company (NYSE:SO), an electric utility company, is the fifth largest holding in Morningstar's index. Its dividend yield of 4.5% is about double the industry yield. The company has a cash-flow-to-debt ratio of 0.28, based on operating cash flow and long-term debt. Its ROE based on trailing-twelve-months is 12.3%, above its industry's 0.1%. The company's annual EPS growth averaged 3.9% over the past five years, and is expected to average 5.0% for the next five years. Consensus 2013 EPS estimate revision is negative 1.1% over the past 90 days. The stock is trading below industry multiples at 17.1x trailing and 15.6x forward earnings. Even though Southern Co. has shifted consumption toward cheaper gas, which now powers 41% of the company's capacity, the company is diversifying its plants by type of consumption, having under construction large coal and nuclear plants, which will come online in the next several years. The stock is popular income investment and is one of the holdings of fund managers Phill Gross (Adage Captial) and Louis Navellier.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Dividendinvestr is a team of analysts. This article was written by Serkan Unal, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.