Morningstar Dividend: Four Core Holdings

08/25/2014 9:00 am EST

Focus: STOCKS

Josh Peters

Editor, Morningstar DividendInvestor

Peter Lynch—my first muse on stock investing—made a lot of valuable observations, but perhaps none that is more valuable for portfolio managers than this: Know what you own and why you own it, asserts Josh Peters, editor of Morningstar Dividend Investor.

To make extra certain that I know what we own and why, this feature will be devoted to summaries of some of our current stocks in our Dividend Harvest Portfolio. Here's a look for four buy-rated core holdings.

AmeriGas Partners (APU)—yielding 7.7%

Likes: Strikingly similar to a natural gas utility, but without the regulation of prices or returns on capital. Customer switching costs and industry consolidation provide propane distributors with strong pricing power.

Commodity cost variations are passed directly through to customers. Industry-leading scale and scope boost AmeriGas' returns even further. Cash coverage of distributions is high enough to offset weather variations while funding bolt-on acquisitions.

Concerns: Propane is considerably more expensive than natural gas and propane is slowly losing share on a national basis. Weather patterns could shift, reducing demand for home heating.

Chevron (CVX)—yielding 3.3%

Likes: Chevron's been both smart and lucky with the drill bit in recent years—on an enormous scale—even though most prime areas for exploration are denied to Western oil companies.

It is now investing heavily to develop its vast opportunity set, which should shake output out of a stagnant stretch and generate 4%-5% annual production growth within a few years. Rock-solid finances allow heavy spending as well as a large, steadily rising dividend, which is likely to remain management's top priority for investors.

Concerns: Such aggressive investment outlays may yield subpar returns if energy prices enter a state of secular decline; ExxonMobil's (XOM) strategy of maximizing share buybacks, while holding total output more or less steady, is somewhat more conservative.

General Electric (GE)—yield 3.3%

Likes: GE's energy, transportation, and healthcare infrastructure businesses are basic building blocks of the global economy. Its manufacturing prowess is world-class, while add-on services create sticky customers and recurring, recession-resistant revenue.

GE Capital, whose troubles forced a dividend cut in 2009, is shrinking back to a core that leverages the opportunities offered by the industrial units. Despite the dividend cut forced by the traumas of early 2009, a strong commitment to big dividends lives on, illustrated by six increases issued since mid-2010.

Concerns: The shrinking financial unit is a near-term structural headwind for earnings growth, and a weak global economy is a cyclical one. Acquisitions create risks of overpayment and/or integration challenges.

Philip Morris International (PM)—yield 4.4%

Likes: As the dominant cigarette maker almost everywhere except the US and China, Philip Morris owns seven of the world's top 15 brands and garners premium prices. Global scale adds to profit margins.

Concerns: Global cigarette consumption is tipping into decline. Plain packaging rules could threaten pricing power of premium brands. The company has been slow to offer alternative tobacco products, now heavy spending weighs on profits. Currency is frequently a headwind—a particularly fierce one at the moment—as 100% of profits are earned outside the US.

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