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The U.S. equity markets, particularly the Dow Jones Industrial Average (DJIA), were much more bullish during 2016, than was the case in the prior year. The Dow fell 2.2% in 2015, its first losing year since 2008, but rebounded with a double-digit percentage advance in the recently concluded year. 

Of course, 2016 was shaping up as a fairly humdrum affair itself until Election Day, with year-to-date gains on the leading benchmarks in the mid-single-digit range. Investors, though, appeared energized by prospects that the Trump administration will pursue more-business friendly initiatives than its predecessor. And many Dow stocks were leading beneficiaries of the renewed enthusiasm for equities. In fact, as 2016 entered the home stretch, the DJIA was running neck and neck with the NASDAQ and the S&P 500 Index, but pulled away from its two rival benchmarks during the post-election rally in the equity markets. In all, the Dow ended the year with a gain of 13.4%, thanks in large part to a 7.9% advance during the December quarter. By comparison, the S&P was up 9.5% for 2016, while the NASDAQ rose 7.5%.

Dogs Take Home the Prize

The Dogs of the Dow investment strategy produced market-beating returns for 2016. As a reminder, each year’s Dog pack is made up of the 10 highest yielding Dow stocks at the close of the previous year. Investing equally weighted amounts in these equities at the start of 2016 would have resulted in a gain of 15.9% last year.  By comparison, a similarly constructed portfolio of the other 20 Dow components would have produced a gain of 9.4%.

(Note: Investing equally weighted amounts in all 30 stocks would have resulted in a gain of 11.7% last year. The difference between this and the 13.4% gain cited above is due to the fact that the Index is price weighted, meaning that higher-priced issues have a greater impact on its calculation. In last year’s case, that weighting worked to the advantage of the Index.)

The 10 stocks that made up 2016’s Dogs of the Dow were a mangy-looking bunch as the year got under way. Most were licking their wounds after a rough 2015, which saw more than half suffer double-digit percentage declines in their share prices. The year just ended, though, was obviously a very different story, with each of Dogs making at least some contribution to the Dow’s gains in 2016. (From a return perspective, Pfizer (PFE Free Pfizer Stock Report) was the runt of the litter, as its shares inched ahead less than 1% in price.)

Caterpillar (CAT - Free Caterpillar Stock Report) shares rose 37% in value on the year to take home honors as the Best In Show. The year certainly included its share of challenges for the heavy equipment manufacturer, with sluggish end markets contributing to sizable declines in both sales and earnings. Coming on the heels of a 26% stock price decline in 2015, though, investors saw enough signs of progress to get back on board. 

Chevron (CVX - Free Chevron Stock Report), the second best performing Dog, presented a similar comeback story. Declining energy prices caused its shares to lose more than 40% of their value between mid-2014 and late 2015. Global oil prices, though, bottomed out last winter and the ensuing partial rebound in the crude market helped to restore support for oil stocks. Investors also were encouraged by Chevron’s third-quarter results, which saw the company return to profitability in the back half of 2016 after three consecutive quarters of losses. In all, shares of the world’s fourth largest oil company jumped 31% in 2016, while those of our other oily Dog, Exxon Mobil (XOM - Free Exxon Stock Report), were up a comparatively modest 16% for the year.

Changes in the Pack

The 2017 contingent of the Dogs of the Dow will look a little different from last year’s group. Joining the pack for this year’s run will be The Coca-Cola Company (KO - Free Coca-Cola Stock Report) and Boeing (BA - Free Boeing Stock Report). They will be replacing Procter & Gamble (PG - Free P&G Stock Report) and Wal-Mart (WMT - Free Wal-Mart Stock Report). The eight incumbent Dogs are Caterpillar (CAT), Chevron (CVX), Cisco (CSCO - Free Cisco Stock Report), Exxon Mobil (XOM), International Business Machines (IBM - Free IBM Stock Report), Merck (MRK - Free Merck Stock Report), Pfizer (PFE), and Verizon (VZ - Free Verizon Stock Report).

Coca-Cola (KO) was the second-worst performer among the Dow 30 last year, falling 4% in price. (Non-dog NIKE (NKE Free NIKE Stock Report) brought up the rear, as shares of the footwear and apparel maker declined nearly 20%.) Profits at the beverage giant have essentially been in a holding pattern since 2011, and KO stock, not surprisingly, has struggled to keep pace with its Dow peers over this stretch. We expect 2017 will bring little, if any, improvement on the bottom line. This year’s weakness partly reflects ongoing structural changes, such as the refranchising of the company’s bottling operations, which are slated to be completed this year. These initiatives, along with similar moves in other markets, will likely weigh on profits at the outset, but Coke should ultimately emerge from this transition period as a higher-margin, less-capital intensive business. Thus, even with an uninspiring near-term earnings outlook, signs that the company is executing well on its restructuring programs may be enough to help get this stock out of the doghouse in upcoming quarters.

Meanwhile, Boeing (BA) stock turned in a respectable performance in 2016 (up 8%), but a rapidly rising dividend has helped to vault its yield into the top 10 among the Dow components. In all, the distribution climbed 117% between 2011 and 2016, and the quarterly payout is set to jump another 30% with the upcoming March dividend. Improving operating results have helped to underpin the increases, profits have nearly doubled since 2011, and the aircraft manufacturer appears poised for solid bottom-line gains again this year. In fact, the near- and long-term outlooks for Boeing look generally encouraging, as the company should be able to capitalize on healthy demand from airlines looking to upgrade their aging fleets. Still, with the upcoming hike, the dividend payout ratio will likely climb above 60% of adjusted core profits this year (up from 34% in 2011). Given this, we expect the rate of dividend growth to moderate beyond this year, with increases likely tracking closely to earnings growth, which figures to average 8%-10% annually between 2018 and 2020.

Conclusion

Overall, a Dogs of the Dow strategy will likely continue to have appeal with many investors, particularly those on the conservative side. In fact, Caterpillar (CAT) is the only Dog that doesn’t carry our Highest rank (1) for Safety. (CAT stock, which doesn’t score quite as well on Price Stability as the others, is a 2 (Above Average) for Safety.) And consistent with the criteria for Dog status, all of these stocks offer a dividend yield that is at least 100 basis points above the Value Line median. Finally, we are relatively optimistic about the year-ahead price performance prospects for the group. Boeing (BA) recently dropped to a 4 (Below Average) for Timeliness, but the rest of these equities are ranked to either keep pace with or outperform the broader market over the next six to 12 months. 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.