David Harrell: Hi, I’m David Harrell, editor of the Morningstar DividendInvestor newsletter, and I’m here once again with Dave Sekera, who is Morningstar’s chief US market strategist. Dave, thanks for joining me.
David Sekera: Of course. Happy New Year, David.
Harrell: Happy New Year to you. Well, it was a great year for US equity investors once again. Some losses in December, but the broad US market was up more than 20 percentage points for the year, for the second calendar year in a row. Now dividend stocks also did well on an absolute basis, but they were trailing the broad market on a relative basis. Can you shed some insight onto why that happened?
Sekera: Of course. So the Morningstar US Market Index, which is our broadest measure of the stock market, I think was up a little bit over 24% for the year. Now, of course, as you and I have talked about and everyone else has talked about all year, is just how concentrated the returns were in the market thus far this year. So in fact, the top 10 contributing stocks to the market—now, I think they are like 30% of the market cap of the index—but they were accounting for almost 60% of the total market gains. Now when we look at the dividend index, the Morningstar Dividend Composite, that’s up, I think, about 15.7% for the year, which in any other year, people would be very happy with those kind of returns. But the big difference is that that composite index doesn’t incorporate six of those 10 stocks. And so therefore, that really led to the lag in the dividend market behind the broad market.
Harrell: OK. That’s the Amazons, Nvidia, Tesla, and so on. And I know that Nvidia does pay a dividend, but it’s so minute that it’s not going to show up.
Sekera: Yeah. I think that’s a little bit of a game that they tried to play with that tiny dividend that they have out there that for some people that do have that restriction and maybe their portfolio requirements, they can include Nvidia. But again, it’s just so small. It was not included in the Morningstar Dividend Composite.
Harrell: Now when we last spoke in June, you highlighted your dividend picks for the second half of 2024. So just hoping we could revisit some of those. And I know some of them sort of stayed stable or didn’t do much for the last half of the year, but some of them did fairly well in 2024.
Sekera: Exactly. So why don’t we just start off with a couple that we would deem losers in the second half of the year. So that would be Kraft Heinz, Realty Income, and Verizon. Now like you said, they were essentially unchanged. I think each one was down about $1 in the second half of the year. But once you incorporate the two dividend payments that you would have received over that same time frame.
Harrell: Staying even on a total return basis.
Sekera: Stay even or maybe just below even. So again, absolute performance, not all that great. But again, these are still stocks that we still get a lot of value in. They still pay very high dividend rates. And overall, we still think that they’re pretty attractive today.
Harrell: OK, good. And then about the ones that did better in 2024?
Sekera: Yeah. So the one that performed the best is Entergy. That was up, I think, 42% in the second half of the year. And at this point, not only has it gone from a 4-star stock, but it’s rallied so much it’s now a 2-star stock, which now puts that into overvalued territory in our mind.
Harrell: And what were some of the other picks of 2024 that finished the year well?
Sekera: We had a couple others that did pretty well in the second half of the year that were up about 20%—a few a little bit below, a few above—but that included Clorox, Energy Transfer, Wisconsin Electric, and USB. So each of those up about 20%. And then lastly, the two REITs that we had recommended, HealthPeak and Realty Income, were only up a couple of percentage points each.
Harrell: OK, got it. Now, when we look ahead for 2025, based on current market valuations, what are your expectations for US stocks in general in 2025, and then maybe for the dividend universe?
Sekera: Sure. So coming into the year, the US market right now is trading at about a 3% or 4% premium above a composite of our intrinsic valuations. Not necessarily overvalued, but certainly in that area that I consider to be relatively stretched at this point in time. So I’m really not expecting much as far as principal appreciation from a broad market index level, at least and probably till the second half of the year, once I think earnings can start to catch up to where valuations are. So in that kind of environment, I’m really thinking that dividend stocks are a good place to be in the first half of the year, where you can at least capture some of those high dividends for the next couple of quarters. I also like that those stocks are going to be lower in duration. So if we do have interest rates continuing to climb, those would perform better. And of course, then we also have the unknowns of exactly what a Trump presidency is going to bring here in the first quarter and even into the second quarter. So I think that there is probably more downside risks of the market in the short term than upside risk. So therefore, I like a lot of these dividend stocks, which of course are more often than not in the value category.
Harrell: Right, just defensive in nature almost.
Sekera: Exactly.
The 10 Undervalued US Dividend Stocks for 2025
- Kraft Heinz KHC
- Johnson & Johnson JNJ
- Verizon VZ
- Realty Income O
- Healthpeak DOC
- United Parcel Service UPS
- Bristol-Myers Squibb BMY
- Devon Energy DVN
- Portland General Electric POR
- FirstEnergy FE
Harrell: So when we look at your picks for 2025, I know that some of your 2024 picks have remained on your list, including one that’s trading at a substantial discount to fair value.
Sekera: Exactly. And that’s Kraft Heinz—trades at about a 45% discount to our intrinsic valuation, puts it well into that 5-star territory. I believe that dividend yield on that stock is about a 5.25%. Again, it’s a company that we think is on the right track. In fact, we actually just awarded it a narrow economic moat last year. So it has some industry fundamentals that it needs to work through. But for that individual company, we think it looks pretty good here.
Harrell: OK. And I know two more of your returning picks are trading in 4-star territory right now.
Sekera: Exactly. So first up is going to be Johnson & Johnson, very high-quality company, wide economic moat, Low Uncertainty rating, 4-star-rated stock, trades at a 12% discount, pays over, I think, a 3% dividend yield. So I think that’s a very high-quality, very attractive dividend stock, in my mind. And then the other one is Verizon. And I think we’ve talked about Verizon several times over the years. And again, the investment thesis here with the wireless industry is that, looking forward, we think that over time, with only three players really in the wireless industry, it’ll act more and more like an oligopoly. We’ve actually seen that over the past couple of quarters. Companies have been competing less on price. And so therefore, we’re starting to see margin expansion. And again, Verizon pays well over a 6% dividend yield. So for the people really looking for that high dividend yield and the stock still trading intrinsic valuation, I think that one also looks very interesting.
Harrell: Great. Now, I know with Verizon, as you say, very compelling dividend yield right now, dividend growth has been pretty modest and is looking like with the Frontier acquisition, it’s probably going to be, in terms of future dividend growth, on the low end of things for a few years.
Sekera: True, but it is paying a much higher dividend yield than its competitors, AT&T and T-Mobile. And it’s interesting too, if you look at the stock performance in 2024, AT&T had a really great year, whereas Verizon was up a bit, but not nearly as much. Right now, the market seems to be preferring AT&T’s strategy of building out their own fiber, whereas you mentioned Verizon has gone out and been buying fiber assets instead. But again, we still think that that divergence leads to that intrinsic margin of safety that we see at Verizon, whereas AT&T, even though we’ve recommended that in the past, is now a 3-star-rated stock.
Harrell: And I think your last two picks, returning picks, are both real estate investment trusts and both have pretty compelling yields right now.
Sekera: Exactly. In fact, both of them are 5-star-rated stocks. They trade both at about a 30% discount to fair value. And they both pay heavy dividend yields, I think around 6%. Of course, real estate last year was certainly the most hated asset class across Wall Street for much of the year. It started to recover on the third quarter, but then we saw a selloff as interest rates started to go up in the fourth quarter last year. So on my mind, both Realty Income as well as HealthPeak both certainly look attractive to me for real estate investors looking for those high dividend yields.
Harrell: So let’s move on to your new picks for 2025. And I know that the first several on your list have wide economic moat ratings from Morningstar analysts as well as Medium Uncertainty ratings. Can you give us your rationale for why these stocks are making your list for 2025?
Sekera: Of course. So first up is going to be United Parcel Service, UPS. That stock was under a lot of pressure last year. They had to renegotiate their wage contracts, and they saw their operating margins contract because of that. But they’ve been putting through a number of different cost-saving measures. We’re also expecting some top-line growth this year. So we think the combination of that will bring the company back to earnings trajectory of our long-term view on that company. But that stock is a 4-star-rated stock; trades at a 15% discount to our long-term intrinsic valuation. I believe the dividend yield right now is over 5%. So I think it looks pretty attractive from a couple of different fronts.
Harrell: Yeah, that yield is above its five-year average because we’ve seen the share price come down over the past couple of years. And what’s the next wide moat name that made your list?
Sekera: Sure. It’s going to be Bristol Myers. Again, another 4-star-rated stock trading at about a 15% discount to fair value. Over a 4% dividend yield. And again, I think it’s just as simple as we don’t think the market is giving the company nearly enough credit for its pipeline, for its research and development, for the drugs that they’re working on. And when we expect a number of those to get approved by the FDA over time. And this is also probably one of the most value-oriented stocks out there today when you look at earnings from last year, those earnings we think are going to be artificially low just because of some accounting charges that they had to take. We think on a more normalized basis, going forward, stocks only trading at a forward P/E of about 7 times.
Harrell: OK. And I believe Bristol actually just raised its dividend last month as well by a little over 3%. And your third wide moat name is a little different in that it has a variable dividend policy. Can you explain that a little bit?
Sekera: Sure. So this pick is going to be in the energy sector and it’s Devon Energy. It’s a stock where it’s still under a lot of pressure just because oil prices really have gone nowhere over the short term. But we see a lot of value in this company; trades at a 30% discount puts that in the 5-star range. Now, you mentioned the dividend policy here is variable in that they have a specific capital allocation goal to return 70% of free cash flow to shareholders every year. So I think for an investor that’s looking for a very steady and stable dividend, this may not necessarily be the best pick for you. But for investors, they can take a little bit of variability and still capture what we consider to be relatively high dividend yield. This one I think is very attractive.
Harrell: OK. And that 70% cash being returned to shareholders, that could be via the dividend or it could be in some cases via buybacks.
Sekera: Exactly. And it’s just going to depend on what the company thinks of their own share prices when they make those decisions at the board level.
Harrell: OK. And I believe your final two new picks for 2025 are both from an industry where we saw a really wide swing in valuations over the past year or so.
Sekera: Yeah. So it’s the utility industry. And this is really an interesting one where back in October 2023, Travis Miller, who’s our lead analyst for utilities, was really pounding the table talking about that. He thought the utility industry had fallen way too much in 2023. From his view, fundamentally, things looked as good as they had ever been in the utility sector. Yet valuations on a price/fair value basis were actually some of the lowest levels we’d seen over the past decade. Now, the utility sector in 2024 actually had a really, really good year. That’s a combination of two things. One, the industry coming into the year we thought was just undervalued on a pure fundamental basis.
And then two, it became a second derivative play on artificial intelligence. Of course, AI, GPUs, and chips require multiple times more electricity than traditional computing. And so that really led to a huge rally in the utility sector. Now, in our view, that sector overall has run up too far. By November, it actually got to some of the highest valuations as compared with our long-term intrinsic valuation that we’ve seen over the past decade. Now, a combination of valuations being high and interest rates going up late in the year caused that sector to sell off a little bit. I still think the sector is a little bit overvalued here, but at least now this pullback has given us a couple of different opportunities to find some pretty decent dividend-paying stocks. So the two I’m looking at today are going to be Portland General and First Energy, both 4-star-rated stocks. Both have a narrow moat, Low Uncertainty. Of the two, Portland General looks to be a little bit cheaper, trading at about 20% discount to fair value, whereas the others only trading at a 9%, but still both of them offering well over 4% dividend yields.
Harrell: Great. Well, Dave, thanks for sharing your insight. It’s always great to hear from you. I’m hoping we can sit down again maybe in June to revisit some of these picks.
Sekera: Of course, it’ll be great talking to you then.
Harrell: I’m David Harrell from Morningstar DividendInvestor. Thanks for watching.
Watch 10 Top Dividend Stocks for 2024 for more from this series.
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