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5 Dow Dividend Stocks to Beat the S&P - views
BALTIMORE (Stockpickr) -- Do you have any dogs in your portfolio? You should.
As stocks shake off their correction over the last month, the big question most investors' minds is which names make sense to build a position in now. With quality names still taking the lead in 2013's rally, the "Dogs of the Dow" provide a pretty viable answer.
For the last two decades, the Dogs of the Dow has been one of the most widely circulated investment strategies out there, offering individual investors with simple formula to beat the market: Simply buy the 10 highest-yielding Dow stocks, rebalance once a year and hold on. So should you be buying the dogs this summer?
When Michael O'Higgins introduced his strategy in 1991, it took the market by storm; backtesting showed that the Dogs of the Dow strategy significantly beat the broad market from the 1920s on. The justification was that the big names of the Dow don't kowtow to market conditions, so their high dividends reflect strong fundamentals trading cheaply. But the strategy got a black eye during the 1990s, when it trailed the market by a significant clip.
It shouldn't have been a huge surprise that the Dogs of the Dow failed to beat the market during the bull run of the 1990s. During the tech bubble, staid Dow names couldn't possibly move as much as the more volatile tech names that were gaining increasing weight in market indices. While some market watchers have written off the Dogs strategy as a case of data mining bias gone awry, the fundamental argument for buying high-yielding Dow stocks negates at least part of that argument.
That's especially true in the zero-rate environment we're in now.
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.
2013 is turning out to be a pretty tepid year for AT&T (T). The $50 billion communications stock is effectively flat year-to-date, ignoring the ups and downs along the way. But investors' returns haven't exactly been zero. AT&T's massive dividend payout currently works out to a 5.06% annual yield. That dividend gives it top billing on our list today.
AT&T is the incumbent telephone company in many parts of the country, but the firm is better known for its AT&T mobility business, which boasts more than 92 million cellular subscribers. That customer Rolodex makes AT&T the second-largest wireless carrier in the U.S. AT&T created a coup when it began offering the iPhone in 2007, enjoying nearly four years of exclusivity with the extremely popular device. Today, approximately 40% of AT&T's customers are iPhone users, a heavy skew towards the higher revenues per user that smartphone customers bring in. As AT&T continues to convert its existing cellular users to smartphones, margins and sales should still have room to expand.
While AT&T's cellular business may have more visibility, investors shouldn't forget about the firm's legacy fixed line business. Those landlines provide significant cash flows, and the infrastructure offers a reasonably deep economic moat. Bundled packages provide a growth platform for AT&T's fixed lines, even if they're less exciting than mobile. With a payout ratio of just 50%, AT&T has another $10 billion in free cash flows that it can potentially use to reward investors.
Even though AT&T trades for a relatively hefty earnings multiple, its dividend payout more than makes up for the appearance of a high price tag on shares.
Intel (INTC) owns the PC processor market. Unfortunately for the chipmaker, industry headwinds in the computer business have made its 80% market share in microprocessors look slightly less appealing in the last few years. Intel's revenues dipped in 2012 after a strong showing in 2011, and net margins are on the decline three years running. But that doesn't change the fact that investors are overcompensating their unloading of this tech titan.
Despite the dip in sales, Intel's numbers are massive. The firm generated $53 billion in sales last year, and it turned $11 billion of that into profit. For the $115 billion chipmaker, that's like turning 10 cents of every dollar invested back into profits. That's too low of a multiple for this business. While computer manufacturers see their profits get eaten away from commoditization, Intel's impact has been much more tolerable; after all, eight out of 10 PCs get their processors from Intel.
Intel has an important connection with AT&T: mobile devices. The huge turnover in the mobile device market -- both phones and tablets -- is a huge opportunity for Intel right now. While Intel is the underdog in the mobile space, that just means that there's room for the firm to materially grow its top line. Currently, Intel's dividend weighs in at 3.89%, making it one of the highest-yielding blue-chips in the tech sector.
AT&T's top rival, $145 billion Verizon Communications (VZ), is another name that makes our list of Dow Dogs. Verizon, like AT&T, is a major mobile and fixed-line communications carrier, boasting a landline network that reaches one in four U.S. homes and a mobile phone network that's 100 million customers strong.
While Verizon Wireless is the biggest phone carrier in the country, VZ isn't the largest mobile carrier stock. The reason? Overseas carrier Vodafone (VOD) owns 45% of Verizon Wireless -- which means that VZ shareholders "only" lay claim to around 55 million wireless subscribers. A considerable chunk of Verizon's efforts (and its CapEx) have been spent on its wireline networks in recent years. The firm spun off many of its legacy assets to Frontier Communications (FTR) in order to bankroll its costly FiOs fiber optic network. FiOs isn't cheap (some estimates put CapEx costs at $4,000 per installed home), but it's the future of residential and commercial connectivity.
By biting the bullet on infrastructure spending now, Verizon gains a dramatically better network than peers at a time when rates are next to zero and most big cash generators are looking for a better way to invest their corporate treasuries.
That's not to say Verizon has been ignoring conventional means of peeling off its cash. The firm currently shells out a 4.04% dividend yield that, while not as hefty as AT&T's, is plenty substantial in its own right. While Verizon's business is capital intense and its debt load is hefty, subscriptions create plenty of cash to keep on rewarding shareholders too.
Along with the rest of the pharmaceutical industry, Merck (MRK) is having a good year in 2013. Shares of the $143 billion big pharma company have rallied more than 16% year-to-date, besting the S&P 500's impressive performance by about 100 basis points. Then, tack on a 3.61% dividend yield to the equation.
Merck has been busy in recent years. While the guillotine of patent drop-offs has been edging closer and closer to big pharma's neck, Merck has been hard at work adding attractive new products to its pipeline -- and bringing them to market. While the firm already lost patent protection on its blockbuster asthma drug Singulair in August 2012, the loss is being offset by newcomers such as diabetes drug Januvia and HPV vaccine Gardasil. Merck is considerably U.S.-biased; the firm still earns half of its revenues stateside, a fact that should get a boost from healthcare initiatives that increase access to pharmaceuticals.
With a net cash and investment position of almost $8 billion, Merck has the wherewithal to keep on building its pipeline without turning to the capital markets. The firm's hefty net margins should keep those coffers stuffed in 2013 and beyond.
DuPont (DD) built a $34 billion annual chemical and materials business through innovation. The firm's labs have been the birthplace of technologies like Kevlar, Nomex, Tyvek, and Corian. More recently, though, DuPont has been carving out a lucrative niche in the agricultural chemical world, building up its genetically modified seed business and becoming one of the key suppliers of crop seeds in the world. That's helped to fuel double-digit margins in the bottom line and top-line numbers that have eclipsed pre-recession revenues in each of the last two years.
DuPont's considerable diversification is one of its most attractive attributes. Because the firm earns its sales across a handful of disparate industries, it's able to smooth out the cyclical ups and downs that usually harangue chemical companies. The acquisition of Danisco in 2011 furthers that diversification by adding a mature food additives business to the mix. New R&D efforts at Danisco to produce biofuels and a new synthetic rubber could add important new business to DuPont's books as well.
Because DuPont is a big ship to turn around, changes to the firm's sales mix have been relatively slow. Even so, there's a lot to like about a management team that is willing to forego near-term success in favor of longer-term profits. Right now, DuPont pays out a 3.34% dividend yield, enough to round out the top five Dogs of the Dow.
To see these stocks in action, check out the at Dogs of the Dow portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation. Follow Jonas on Twitter @JonasElmerraji