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3 American Dividend Stocks Are Selling for Cheap

Stock investors looking to the US market for extra income and potential capital appreciation should check out these names

Adam Zoll 10 September, 2012 | 8:00AM

For many income-oriented investors frustrated by the low payouts available from high-quality bonds, the search for added yield continues. Some investors who are willing to take on added risk are finding US stocks to be an attractive option. The S&P 500 index of large companies currently yields around 2.25%, and many dividend-paying stocks yield far more than that. Meanwhile, the Barclays Capital Aggregate Bond Index, a widely used proxy for the US investment-grade bond market, yields less than 2% currently, and most money market fund investors are barely in the black.

By investing in stocks that have sustainable competitive advantages, that pay healthy yields, and that currently sell below Morningstar's fair value estimates, investors willing to take on some equity risk can obtain a boost in yield and potentially some appreciation in stock prices as well.

For investors wary of the market or uncomfortable with the added risk inherent in moving money into stocks from cash or bonds, such a move might not be worth it. But for those willing to take the step, there are many quality American names that can help provide an income boost over what other investment classes are paying.

Be aware that inexpensive dividend-paying stocks are not as plentiful as they were at the start of the year because of market gains and a high level of interest in these stocks. Therefore, paying close attention to valuations is essential.

Below are three cherry-picked quality dividend-paying US stocks that have sustainable competitive advantages. This essentially means that these companies will likely remain leaders in their industries for some time to come. The companies are currently paying yields of at least 3% and have Morningstar Ratings of 4 or 5 stars, meaning they are currently selling at a discount to our analysts' fair value estimates.

Exelon (EXC) 
Yield: 4.3% 
Utilities tend to be above-average dividend payers, and this one also happens to be the largest operator of nuclear power plants in the United States at a time when the country is increasingly concerned about energy availability and the effects of global warming. This competitive advantage helps make it the only utility Morningstar rates as having a wide moat. It's also the only 5-star stock on our list, meaning it is selling at a deep discount to our analyst's fair value estimate. A recent $7 billion merger with Constellation Energy helps Exelon add to its large retail base, though regulatory risk in some regions remains a concern.

McDonald's (MCD) 
Yield: 3.1% 
Morningstar analyst R.J. Hottovy recently reduced his fair value estimate for the quick-service restaurant giant, but the firm still sells at a discount and should continue to enjoy competitive advantages as a result of its strong brand, economies-of-scale benefits, and international growth opportunities. McDonald's is in excellent financial shape, generates strong free cash flow, and has a long track record as a consistent dividend payer and share repurchaser. Risks here include increasing competition within the quick-service restaurant industry and volatile commodity prices that could affect the company's bottom line.

Paychex (PAYX) 
Yield: 3.9% 
This human resources outsourcing firm enjoys wide-moat status as a result of high switching costs for its customers, the scalability of its business, and a strong brand. The difficulty of changing payroll services has allowed the company to raise prices without losing the small- and mid-sized businesses that are its primary clients. Paychex is financially strong, with margins that have exceeded 30% during the past decade. Risks include the shaky economy, which could hurt profits if it were to slip back into a recession.

Yields and stock prices as of Sept. 4.

For more information about Morningstar's Star Rating system, read: Stocks: What's Behind the Morningstar Ratings?

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Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Exelon Corp35.89 USD-0.14
McDonald's Corporation99.32 USD-0.35
Paychex, Inc.40.99 USD0.37
About Author

Adam Zoll  is an assistant site editor with Morningstar.com, the sister site of Morningstar.co.uk.