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©2015 Morningstar, Inc. All rights reserved. Josh Peters, CFA Director of Equity-Income Strategy Editor, Morningstar DividendInvestor Morningstar’s Dividend Playbook

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Page 1: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

©2015 Morningstar, Inc. All rights reserved.

Josh Peters, CFA

Director of Equity-Income Strategy

Editor, Morningstar DividendInvestor

Morningstar’s Dividend Playbook

Page 2: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

gJosh Peters, CFA is Morningstar’s director ofequity-income strategy, the founding editor ofDividendInvestor, and manager of its DividendSelect model portfolio

g Launched in January 2005

gReleased companion book in 2008:The Ultimate Dividend Playbook

gReceived over 1,200 dividends thus far fromour active portfolio holdings—all of whichreflect actual, trades in real money,Morningstar-funded brokerage accounts

gReceived 398 dividend increases sinceinception; just 16 dividend cuts

2

Introduction to Morningstar DividendInvestor

Page 3: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

Why Dividends?

3

gPractical advantages for investors

/For retirees, cash to fund regular portfolio withdrawals without having to sell shares

/For savers, cash funds income growth/wealth accumulation through reinvestment

/Better class of companies—typically well-established, defensive, financially healthy

/Makes stocks easier to analyze and easier to own

gMuch-needed discipline for issuers

/Demonstrates ability willingness to reward shareholders directly

/Represents a long-term commitment, enabling investors to return the favor

/Helps block potentially self-serving or dubious allocations of capital

gDividends are the ultimate source of security values

/Bottom line is cash flow—not just to the firm, but directly to the investor

Page 4: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

Best Reason of All: Superior Performance

4

gNumerous academic studies show that high-yielding stocks outperform the market over the long run

gOur study: Highest 30% of yields beat the market in 53 of 60 rolling 10-year CAGRs beginning in 1945

/Average beat of 206bp per year—or an extra $575 after 10 years on each $1,000 invested

Annual data 1945-2014. Source: Data from Kenneth R. French (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html), Morningstar analysis.

-1%

4%

9%

14%

19%

24%

1955 1965 1975 1985 1995 2005

U.S. Market TotalReturn

30% HighestDividend Yields

Page 5: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

Step 1: Defining an Investable Universe

5

gWhile the S&P 500 pays only 2.0%, much higher yields are available, especially in certain sectors—consumer staples (2.6%), energy (2.9%), utilities (3.6%) and telecommunications (4.9%)

gHeavy share buybacks and/or rapid dividend growth without a decent yield are no substitute foradequate current income

gOur basic stock screening parameters:

Premium Stock Screener available at http://screen.morningstar.com/AdvStocks/Selector.html#AnchorSelector, results as of 3/19/2015.

Page 6: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

6

Step 2: The Dividend Drill

Page 7: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

The Dividend Drill: Is It Safe?

7

gDividend safety is the number-onepriority for income investors—more than interest rates, changes ineconomic trends, even valuations

gHow to avoid dividend cuts:

/Economic moats, which defendprofitability and cash generation

/Healthy balance sheets

/Payout ratios that balance incomeagainst internal reinvestmentneeds and a cyclical safety margin

/Continued dividend growth is thebest indicator of safety, thougheven this isn’t perfect ...

Outcomes reflect realized total returns for full holding periods of each active DividendInvestor portfolio position. Data through 3/19/2015. Source: Morningstar

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

350%

Our Record: Outcomes by Dividend Action

IncreasedDividends (89%positive returns)

Flat Dividends(71% positivereturns)

ReducedDividends (19%positive returns)

Page 8: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

The Dividend Drill: Will It Grow?

8

gDividend growth drives total return by:

/Furnishing additional income over time

/Encouraging long-term capital appreciation

gKey drivers of dividend growth:

/Earnings growth: Consider volume expansion,pricing power, future for operating margins,role of acquisitions/share repurchases

/Dividend policy: Will dividends risefaster/slower/equal to per-share earnings?

gUseful approach: “extend the trend”

/Latest 5- or 10-year rate as a stepping-off pointfor consideration of future performance

Data as of 3/19/2015. Source: Morningstar, company reports

0.38

0.76

1.14

1.52

1.90

12

24

36

48

60

1995 2000 2005 2010 2015

General Mills GIS Stock Px (LH) Div. Rate (RH)

10-Year Earnings and Dividend SummaryDivPaid Payout DivPaid Payout

FY04 1.43 0.55 39% FY11 2.48 1.12 45%FY05 1.37 0.62 45% FY12 2.56 1.22 48%FY06 1.45 0.67 46% FY13 2.69 1.32 49%FY07 1.59 0.72 45% FY14 2.82 1.55 55%FY08 1.76 0.79 45% CAGR: 7.1% 10.9%FY09 1.99 0.86 43%FY10 2.30 0.96 42% FY15e 2.82 1.67 59%

CoreEPSCoreEPS

Page 9: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

The Dividend Drill: What’s the Return?

9

gTotal return is always the bottom line, notincome alone or growth/capital gains alone

g Is the absolute return indicated by a safe currentyield plus sustainable long-run dividend growthacceptable?

/Hurdle returns of 7.5% for low risk companieswith above-average yields;

gAm I paying a sustainable valuation: willtotal return = dividend yield + dividend growth?

/Consider valuation: Our main indicator isprice/fair value (preferred below 1.0)

gPreferred outcome is total return > yield+growth,valuation discipline necessary to avoid shortfalls

Data as of 3/19/2015. Source: Morningstar

0.74

1.48

2.22

2.96

3.70

12

24

36

48

60

1995 2000 2005 2010 2015

Realty Income O Stock Px (LH) Div. Rate (RH)

0.00

0.56

1.12

1.68

2.24

2.80

28

56

84

112

140

1995 2000 2005 2010 2015

Johnson & Johnson JNJ Stock Px (LH) Div. Rate (RH)

Page 10: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

Dividend Drill in Action: Verizon Communications

10

gThe Dividend: Is It Safe?

/Free cash flow is the best indicator; coversdividends about 1.5 times

/Economically defensive business;narrow moat and BBB credit rating

gThe Dividend: Will It Grow?

/Dividend increases each year since 2005

/Modest but accelerating growth recently

gThe Dividend: What’s the Return?

/Trading slightly below $50 fair value

/4.5% yield plus 4%-5% estimated dividendgrowth suggests roughly 9% total returns

Data as of 3/19/2015. Source: Morningstar, company reports

0.62

1.24

1.86

2.48

3.10

14

28

42

56

70

1995 2000 2005 2010 2015

Verizon VZ Stock Px (LH) Div. Rate (RH)

10-Year Earnings and Dividend SummaryDivPaid Payout DivPaid Payout

FY04 2.59 1.54 59% FY11 2.15 1.96 91%FY05 2.56 1.60 63% FY12 2.32 2.02 87%FY06 2.54 1.62 64% FY13 2.84 2.08 73%FY07 2.34 1.65 70% FY14 3.35 2.14 64%FY08 2.54 1.75 69% CAGR: 2.6% 3.3%FY09 2.40 1.86 77%FY10 2.21 1.91 87% FY15e 3.66 2.22 61%

CoreEPS CoreEPS

Page 11: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

Step 3: Portfolio Management

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gWhat drives an individual stock’s returns works even better for a portfolio as a whole

/Our Dividend Select portfolio targets 3%-5% yields, 5%-7% dividend growth, 9%-11% total returns

/Currently yielding 3.9% with 6.1% long-run income growth profile

gEarning yields that are double the market average requires embrace of different results:We go where the (safe and growing) dividends are ...

Data as of 3/18/2015. Source: Morningstar

0

5

10

15

20

25

30S&P 500

Dividend Select

Page 12: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

12

Our Results: Beating the Market Without Even Trying

Data from inception (1/7/2005) through 3/19/2015. Source: Morningstar

-50

0

50

100

150

200

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Cumulative Total Return: DividendInvestor Portfolios vs. S&P 500

Standard & Poor's 500 (CAGR: 7.9%)

Combined DividendInvestor Portfolios (CAGR: 9.2%)

-40

-20

0

20

40

60

80

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Cumulative Price Appreciation

S&P 500

DividendInvestor

-40

-20

0

20

40

60

80

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Cumulative Dividend Return

S&P 500DividendInvestor

32.8 percentage pointadvantage (2.4%/yr)

19.4 percentage pointdisadvantage (-1.2%/year)

Page 13: Morningstar’s Dividend Playbook · Morningstar’s Dividend Playbook. gJosh Peters, CFA is Morningstar’s director of equity-income strategy, the founding editor of DividendInvestor,

Josh Peters, CFA, owns all of the stocks held inthe Dividend Select portfolio, including GIS, JNJ,O, VZ.