5 DJIA Dogs Ready To Growl In 2014
While most investors spend the last quarter of the year looking for the top trades to head into 2014, I'd recommend looking at the bottom of the list for buying opportunities.
Yes, I realize how crazy that sounds.
The thing about focusing on the bottom of the list is that they're the names that are the most ignored. As a result, they're the ones that have the most potential to fly when they impress investors. And as unorthodox as that strategy sounds, I'm not exactly breaking new ground here; it's the basic concept behind the "Dogs of the Dow" strategy that Michael O'Higgins introduced in 1991.
The Dogs of the Dow is a strategy that's built around simply buying the 10 highest-yielding Dow Jones Industrial Average stocks, rebalancing once a year, and holding on. Because yield is inversely related to performance, these big names tend to be lower performers out of the big index's 30 names.
So should you be buying the dogs this fall?
In a nutshell, the Dogs of the Dow strategy works exceptionally well in bull markets, and a whole lot less well when the market is showing signs of weakness. I've certainly made no secret of the fact that I think we're in the early stages of a secular bull right now.
That doesn't mean that you should buy the textbook version of this strategy. With only 30 blue-chip stocks in the Dow Jones Industrial Average index (INDU) (DIA), diversification is a real problem. After all, the super-high yields are contained within a couple of industries. But limit your industry overlap, and this approach starts to look a little more interesting.
In fact, my own research shows that paring down the Dogs of the Dow to a more concentrated portfolio of five stocks, rather than 10, has delivered some stellar outperformance in the last decade without ramping up the risk. So today, we'll take a closer look at five Dogs of the Dow stocks.
AT&T
First up is AT&T (T), a stock that's held the title of the highest-yielding Dow component for quite some time. As I write, the firm pays out a hefty 5.27% dividend yield. AT&T is one of the biggest communications firms in the world, with nearly than 95 million wireless customers, 30 million landline customers and 16 million internet subscribers. That huge installed base gives AT&T some big advantages when it comes to selling bundled services to its existing customer Rolodex.
T Daily Chart
It may sound surprising, but AT&T recently got a big valuation boost from its top rival, Verizon (VZ). That's because Verizon is overpaying considerably to obtain complete ownership of its wireless unit from Vodafone (VOD). Basically, the firm is shelling out $130 billion for the 45 million customers that fall into VOD's share of the business. At the same time, AT&T's 95 million customers and entire fixed line business is being valued by the market at just $180 billion. That's an insane mispricing, and it still hasn't been worked into share prices months later.
AT&T has a great history of rewarding investors. The firm generates substantial free cash flows each quarter -- and with interest rates near zero right now, it typically allocates most of its cash to pay investors through dividends and stock buybacks. With AT&T trading at a big discount to Verizon, now is a good time to think about being a buyer.
Intel
Intel (INTC) is another Dow Dog that's looking remarkably cheap right now -- and that's in spite of a 16% rally in shares year-to-date. I ntel is the biggest microchip maker in the world. In fact, the firm owns around 80% of the global microprocessor business, manufacturing the "brains" behind the vast majority of computers coming off of assembly lines. In spite of that dominant position, there's a lot of room for growth ahead of Intel.
INTC Daily Chart
In the last few years, mobile devices have been quietly overtaking conventional PCs as consumers' primary computers. Intel has been working hard to take home a bigger piece of that pie by scaling down its expertise in higher-end computer processors to fit the smaller (and more energy efficient) form factor of tablets and phones. The obvious benefit to that is increased speed. While rivals work on getting more juice out of their existing chip architecture, Intel is "just" working to make their speedy chips more battery friendly.
That's a sound strategy going forward.
Intel's Dow Dog status comes thanks to a hefty 3.93% dividend yield, one of the largest in the tech sector. That dividend payout is backed by a stellar balance sheet with more than $13.8 billion in net cash and investments. That's enough to push INTC's ex-cash P/E ratio into the single digits. There's no question that INTC looks cheap at current levels.
Merck
2013 has been a pretty quiet year for Merck (MRK). Shares of the big pharma firm have only managed to climb 15% since the start of the year, a pretty decent number for most sectors, but one that falls flat compared to the stellar returns of the rest of the pharmaceutical space. Still, with a dividend payout of 3.55%, Merck makes our list of Dow Dogs worth watching this quarter.
MRK Daily Chart
Merck is a $140 billion pharmaceutical firm with a portfolio of well-known drug names that includes Gardasil, Claritin, and Zocor. Singulair has long been Merck's crown jewel, but the firm lost patent protection in the middle of last year, opening the field to generic competition. To fight off the threat of patent drop-offs and cut costs, Merck acquired Schering Plough in 2009, adding an attractive drug pipeline to its existing development efforts. Those new products hold a strong shot at undoing the revenue losses from Singular and other expiring patents.
Like Intel, Merck currently sports a strong balance sheet with plenty of liquidity - more than enough to cover dividend payouts and continue investing in research and development for new drugs. Keep an eye on earnings slated for Oct. 28.
Chevron
$230 billion energy firm Chevron (CVX) is the financially fittest of the oil and gas super majors. Chevron also sports a dividend yield of 3.36%, making it the higher-yielding of the two energy giants in the Dow. As the No. 2 oil company in the U.S., Chevron produces around 2.6 million barrels of oil equivalent each day -- and sports proven reserves of 11.3 billion barrels.
CVX Daily Chart
Here's why you should pay attention to this Dow Dog:
Even though oil prices have relatively sideways in 2013, they're still very much on the high end of their historic range. That means that Chevron is able to collect more for every barrel it pulls out of the ground, and it's able to keep more oil projects economically viable in this environment. While competitors have been adding natural gas (UNG) to their reserves, CVX has kept its production mix skewed heavily towards oil (USO); around 70% of the firm's production is oil today, leading to a much larger payout while peers wait for natgas prices to rebound.
Sure, Chevron is investing more in natural gas right now, but it's been conservative in its exposure to this point, and that's been a prescient move. Chevron's balance sheet has been equally impressive. While the energy sector is very capital-intense, CVX actually sports a $27.5 billion net cash and investment position right now. That's enough to pay for 12% of the firm's market capitalization outright.
Again, here's a stock with a single-digit P/E multiple right now. Bottom line: CVX looks cheap.
General Electric
Last up on our list of Dogs of the Dow is General Electric (GE), the industrial conglomerate. GE is most investors' idea of a prototypical blue chip, and it's got the dividend payout to prove it; right now, GE pays a 3.09 yield. As the economy's green shoots turn greener, GE's exposure to the global industrial cycle should prove lucrative for investors.
GE Daily Chart
General Electric has a hand in making everything, from jet engines to wind turbines to medical equipment. At first, GE's businesses look disparate: What does a refrigerator have to do with a sonogram machine? But the firm has found great success in making the puzzle pieces fit together and share technologies and customers across business lines. One common thread is that GE's products are capital intense for their customers -- that means that a liquid credit market is critical for GE's success. Luckily, it doesn't get much more liquid than it is right now.
One of GE's biggest businesses is GE Capital, the firm's financial services arm. That captive finance arm almost sunk GE just a few years ago thanks to huge bets on the consumer sector, but most of the skeletons have been shaken out of the closet at this point. As equities continue to do well, so should GE Capital and its parent company.
Courtesy of Jonas Elmerraji, thestreet.com