4 Cheap Dividend Stocks With 25% Upside

BOSTON (TheStreet) -- Value-focused Morningstar (MORN) currently bestows its top five-star rating on only 20 stocks, four of which are dividend-paying blue-chips. The four multi-national companies, three of which are Dow components, sell for sizable discounts and are poised to profit on rapid emerging-markets expansion. Below, they are ordered by upside.

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4. Procter & Gamble ( PG) sells consumer products ranging from dog food to shampoo. As the leading company in its field, with outstanding brand recognition and internal research capabilities, P&G has a "wide economic moat" or sustainable competitive advantages, along with higher margins, lead market share across numerous product categories and so-called economies of scale through its manufacturing and distribution network. Morningstar is encouraged by internal cost-saving initiatives, which should help offset recent price cuts and potential for costlier inputs. It expects P&G to grow 2011 sales 4%, below current guidance.

Morningstar valued P&G's stock at $77, suggesting 25% upside to intrinsic fair value. That target is consistent with 19-times 2011 projected earnings and an enterprise value to EBITDA ratio of 19. Developing markets offer tremendous growth prospects. It's absolutely critical that P&G develop brand awareness among burgeoning middle classes overseas. The downside: Emerging-markets sales are currently reliant on lower-margin items. Morningstar forecasts a 21% operating margin over the next five years and long-term sales growth at 4.5%. P&G yields 3.1%. The payout has grown 11% a year, over a five year span.

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3. Johnson & Johnson ( JNJ) is a health-care company, with pharmaceutical, consumer and diagnostics divisions. J&J, like P&G, has a wide economic moat, in Morningstar's view, but the researcher recently cut its fair value estimate on the stock to $75 due to "slowing demand for products in Johnson & Johnson's device and consumer business." Its target still suggests an attractive 26% of upside in J&J shares. Product recalls and drug-patent expirations may weigh on results in 2011. Still, for long-term investors, J&J is a best-in-class health-care stock. Morningstar likes J&J's diversified revenue stream, expecting 4% sales growth for 10 years.

J&J yields 3.6%. It has increased the payout for 45 consecutive years, ranking as a so-called dividend aristocrat. The distribution has grown 9.2% and 10% annually, on average, over three and five years, respectively. J&J faces risk from $2 billion of patent-sales-loss exposure until 2012. Morningstar is optimistic about late-stage pipeline prospects as well as medical-device innovation, such as new ceramic orthopedics and minimally-invasive surgical tools. Patent expiration could pressure margins until 2012, as a higher share of sales come from lower-margin units. New drugs and cost cuts may offset this.

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2. Abbott Laboratories ( ABT) is another diversified, wide-moat health-care company, with pharmaceutical, medical-device and nutritional products. The company generates roughly 60% of sales from its pharmaceutical unit. Although Abbott has a bit less cash on hand than its peers, Morningstar is impressed with its cash-flow generation and success at identifying and integrating acquisitions. Like J&J, diagnostics and nutritional lines, though less relevant than pharma, provide ever-important diversification and a degree of insulation from patent expiration. Abbott's autoimmune agent Humira grew sales 19% in 2010. Its cardiovascular drug Tripilix has "blockbuster potential."

Morningstar's $68 fair-value target is consistent with a return of 39%. That price is equivalent to 15-times the 2011 earnings forecast, a sizable premium over the average industry multiple of 10, which Morningstar says is justified based on growth prospects. The risk and, therefore, upside is greater in Abbott than in J&J or P&G. Any failure of late-stage drug candidates would have a material impact on Abbott's stock price. Also, growth is heavily dependent on Humira and Xience. Abbott yields 3.9%. The distribution has grown 11% annually, on average, over a three year span.

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1. Cisco ( CSCO) is the world's largest networking-equipment maker. It boasts lead market share in switches and routers and enjoys a wide economic moat, like the aforementioned companies. Still, Cisco is among the worst-performing and most-loathed U.S. equities. Its stock has fallen -- by as much as 16% -- in response to the past four quarterly earnings releases. Shares are down 13%, annualized, since 2008 and 35% over 12 months, underperforming technology benchmarks and ranking as the worst-performing Dow component. The recent quarterly dividend initiation, at 6 cents, converts to an annual yield of 1.4%, with a projected payout ratio of less than 20%.

There are reasons to be bullish on Cisco: compelling value, overwrought pessimism, $25 billion of net cash on hand, leading market share in networking gear and the newly introduced dividend. Morningstar values Cisco at $30, assuming 8.5% annualized organic growth through 2015. That price target suggests that Cisco shares will appreciate 72%. Risks are plenty.

But, Morningstar has incorporated numerous negatives into its modeling, including the dilutive aspects of non-core initiatives, such as the consumer and set-top box businesses, gradual margin declines and even modest share erosion. Still, Cisco offers investors the opportunity to purchase a near-monopolistic tech company at a historical discount. Consider that Cisco sells for a trailing price-to-earnings ratio of only 13, a 35% discount to its five-year average multiple.

-- Written by Jake Lynch in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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