About the Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks.

Josh manages DividendInvestor's model dividend portfolio, the Dividend Select Portfolio. Josh joined Morningstar in 2000 as an automotive and industrial stock analyst. After leaving in 2003 to join UBS Investment Bank as an equity research associate, he returned to Morningstar in 2004 to develop DividendInvestor.

Peters holds a BA in economics and history from the University of Minnesota Duluth and is a CFA charterholder. He is also the author of a book, The Ultimate Dividend Playbook, which was released by John Wiley & Sons in January 2008.

Investment Strategy

Dividends are for everyone regardless of age. The outcome of owning dividend-yielding stocks is the key variable-higher-yielding stocks with safe payouts being less risky while affording investors who don't need current income the ability to reinvest/reallocate the capital.

The goal of the Dividend Select Portfolio is to earn annual returns of 9% - 11% over any three-to-five year rolling time horizon. We further seek to minimize risk, as defined by the probability of a permanent loss of capital. For our portfolio as a whole, this goal is composed of:

3% - 5% current yield
5% - 7% annual income growth

Sep 27, 2016
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Josh Peters, CFA
Equities Strategist and Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks.Josh manages DividendInvestor's model dividend portfolio, the Dividend Select Portfolio.
Featured Posts
Earnings for General Mills -- The Week in Dividends, 2016-09-23

DividendInvestor℠ focuses on the activities of portfolios of Morningstar, Inc. that are invested in accordance with the Dividend Select strategy. These portfolios are managed by Morningstar Investment Management LLC, a registered investment adviser, who manages other client portfolios using these strategies.

From the DividendInvestor news file this week:

It was a relatively light news week for the holdings of Morningstar's Divided Select portfolios.

On Wednesday, General Mills GIS announced its earnings for its second fiscal quarter. In response, the Morningstar, Inc. analyst for the firm reaffirmed a $54 fair value estimate for its shares, despite tepid top-line performance for the quarter. (Please see the analyst note below.) A new valuation report was published for Procter & Gamble PG, with the fair value estimate left unchanged at $92 a share (analyst note below). Meanwhile, Wells Fargo WFC stayed in the headlines with CEO John Stumpf's appearance on Tuesday before the Senate Banking Committee. On Thursday, Warren Buffett said he doesn't plan to talk about employee misconduct at Wells Fargo until he files a quarterly update on Berkshire Hathaway's BRK.B stock portfolio in November. (Berkshire owns approximately 10% of Wells Fargo's shares.)

The Fed meeting concluded on Wednesday with the anticipated result--no immediate rate change, though Fed chair Janet Yellen said she expects an increase in the federal funds rate by the end of the year.

Coming up next week:

Paychex PAYX is scheduled to announce its quarterly results on September 28.

Best wishes,

David Harrell
Managing Editor, Morningstar DividendInvestor

News and Research for Dividend Select Portfolio Holdings

General Mills' Sales Sour in First Quarter, but Continued Cost Management Focus a Plus; Shares Rich
by Erin Lash, CFA | 09-21-16

We're maintaining our $58 fair value estimate for narrow-moat General Mills after incorporating first-quarter results that included a 4% shortfall in organic sales (reflecting a 6% volume retreat), a 30-basis-point contraction in adjusted gross margins to 37.4%, and an 80-basis-point increase in adjusted operating margins to 19.2%. Despite the tepid top-line performance this quarter, our near-term outlook already called for sales to slip nearly 2% this year. Longer term, we still expect General Mills to post accelerating sales gains (up 3%), with slightly more than half of its annual growth from volume and the remainder from higher prices and improved mix. With shares trading in excess of our valuation, we'd suggest investors await a more favorable risk/return profile.

As has been the case the past few quarters, yogurt (which accounts for 15%-20% of consolidated sales) has proven particularly dismal for General Mills, with sales tumbling 15% in the first quarter. Management attributed the bleak performance specifically to lower sales of Yoplait Light (down 29%) and Yoplait Greek 100 (down 33%). We think a portion of this erosion likely reflects consumer' penchant for healthier fare made with simpler, more natural ingredients (at the expense of products that are geared toward dieting), but we also suspect that competitors have taken advantage of the significant decline in dairy costs to lower prices of late. Our concern stems from the fact that this is not the first time the firm has lost ground in the yogurt aisle. More specifically, General Mills was caught flat-footed when Greek yogurt came on the scene. In our view, efforts to more effectively align new products with evolving consumer trends have failed to yield measurable improvement in the face of intense competitive pressures. And we don't think righting its ship in yogurt will prove easy, with management suggesting in July that it could be hard-pressed to post growth in the segment this fiscal year.

One of the bright spots within General Mills' portfolio has been its lineup of natural and organic offerings (we estimate this mix now accounts for 5% of its total sales), which posted a 12% jump in underlying sales through the first three months of its fiscal year. However, despite the more favorable growth prospects--growing 3 times faster than overall grocery sales--we don't expect this will ultimately enhance its competitive positioning and margin profile given the category dynamics. While in general the price premium afforded to organic fare seems to support a brand intangible asset, we don't view this as a sustainable source of competitive advantage for any player in the space and believe the pricing power of the organic aisle may wither if supply catches up with demand or if consumers lose confidence in the quality of organic products--a possibility if the designation transcends too wide and deep to be well regulated.

In an effort to fund additional brand spending, General Mills maintains a stringent eye on taking costs of its business by reducing excess capacity and overhead, targeting to realize $600 million in savings annually beginning in fiscal 2018. This equates to around 4.5% of fiscal 2016 cost of goods sold and operating expenses, excluding depreciation and amortization, which is in line with peers Kellogg and Campbell Soup. We perceive these efforts as prudent in light of the ultracompetitive landscape in which it plays and forecast that General Mills' sourcing and supply chain efficiencies will drive operating margins to around 20% (about 400 basis points above the historical five-year average) by the end of our 10-year explicit forecast.

Procter & Gamble Valuation Update
by Erin Lash, CFA | 09-21-16

Our fair value estimate for P&G stands at $92 per share, which implies forward fiscal price/adjusted earnings of 25 times and an enterprise value/adjusted EBITDA of 15 times.

Overall, we contend the initiative to shed 100 brands over the past two years should enable the firm to focus on the highest-return opportunities. Tepid economic conditions in the U.S. and Europe will impede P&G's near-term growth prospects (which in combination account for more than 65% of the firm's total sales), but our outlook for a top-line increase of about 4% long term remains in place, with nearly two thirds of its annual growth from increased volume and the remainder from higher prices and improved mix.

Globally, P&G's categories grow roughly 3% annually, so to reach the 4% annual sales growth pace we've modeled, the firm would have to grow 1%-2% faster than the markets and categories in which it competes, which we view as achievable, particularly in light of recent strategic efforts. The firm has growth opportunities for its brands in many overseas markets, and in developed markets it remains the share leader in many of its categories. We recognize that growth prospects in several emerging regions, which in the aggregate account for around one third of annual sales, have also slowed. However, we still believe that populations will grow exponentially, urbanization and private investment will create favorable disposable income tailwinds, and a younger consumer base will offer the potential for a lifetime of transactions ahead. We forecast low-single-digit growth in the firm's developed market regions and mid- to high-single-digit growth in its emerging markets.

Beyond reducing the complexity of its operations--which should bolster its profitability--P&G also targets extracting another $10 billion of costs over the next five years by reducing overhead, lowering material costs from product design and formulation efficiencies, and increasing manufacturing and marketing productivity. We think these savings stands to fuel product innovation (including improved packaging) and advertising as well as increased sampling to prompt trial longer term, rather than merely providing a boost to profits. We forecast the firm will allocate 3% of sales for R&D and 11.5% of sales for marketing each year. Our long-term forecast calls for operating margins to improve to more than 24% by fiscal 2026.

©2016 Morningstar, Inc. All rights reserved. The Morningstar name and logo are registered marks of Morningstar, Inc. The information contained in this document is the proprietary material of Morningstar, Inc. Reproduction, transcription, or other use, by any means, in whole or in part, without the prior written consent of Morningstar, Inc., is prohibited. All data presented is based on the most recent information available to Morningstar, Inc. as of the release date and may or may not be an accurate reflection of current data.  There is no assurance that the data will remain the same.

The commentary, analysis, references to, and performance information contained within Morningstar® DividendInvestor℠, except where explicitly noted, reflects that of portfolios owned by Morningstar, Inc. that are invested in accordance with the Dividend Select strategy managed by Morningstar Investment Management LLC, a registered investment adviser and subsidiary of Morningstar, Inc.  References to “Morningstar” refer to Morningstar, Inc. 

Opinions expressed are as of the current date and are subject to change without notice. Morningstar, Inc. and Morningstar Investment Management LLC shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use.  This commentary is for informational purposes only and has not been tailored to suit any individual. 

The information, data, analyses, and opinions presented herein do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Please note that references to specific securities or other investment options within this piece should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment.

This commentary contains certain forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.   

Investments in securities are subject to investment risk, including possible loss of principal.  Prices of securities may fluctuate from time to time and may even become valueless.  Securities in this report are not FDIC-insured, may lose value, and are not guaranteed by a bank or other financial institution. Before making any investment decision, investors should read and consider all the relevant investment product information.  Investors should seriously consider if the investment is suitable for them by referencing their own financial position, investment objectives, and risk profile before making any investment decision. There can be no assurance that any financial strategy will be successful.

Common stocks are typically subject to greater fluctuations in market value than other asset classes as a result of factors such as a company's business performance, investor perceptions, stock market trends and general economic conditions.  

All Morningstar Stock Analyst Notes were published by Morningstar, Inc. The Week in Dividends contains all Analyst Notes that relate to holdings in Morningstar, Inc.'s Dividend Select Portfolio.

David Harrell may own stocks from the Dividend Select and Dividend Select Deferred portfolios in his personal accounts.

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