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A Banner Year For Stocks

The equity markets got out to a good jump in 2013 and pretty much never looked back. Although there was the usual assortment of macroeconomic concerns to keep investors on their toes, stocks climbed the proverbial wall of worry to reach new highs. Among the major U.S. indexes, the tech-laden NASDAQ led the charge, rising 38.3%. While this wasn’t an all-time record, it was the highest level achieved since the bursting of the dot-com bubble over a decade ago. Close behind it was the S&P 500, which advanced 29.6% to its highest ever yearly close. The Dow Jones Industrial Average (DJIA) didn’t fare too badly either, with the blue chip index rising 26.5% for the year.

Meanwhile, the Dogs of the Dow outperformed their DJIA benchmark. Investing equally weighted amounts in the 10 Dow components with the highest yields at the start of the year would have resulted in a gain of 30.3% in 2013. That makes for three out of the last four years in which the strategy beat out a balanced portfolio of all 30 Dow stocks.

(Note: Investing equal amounts in all 30 Dow stocks (and making allowances for the three stocks swapped out of the index in September) would have generated a 28.7% increase in market value. This is slightly different from the DJIA’s aforementioned results, largely because that index is price weighted. That is to say, higher priced stocks have a greater impact on performance.)

Performance Leaders

By far and away, the most impressive showing among the Dogs was the 96.4% advance exhibited by shares of Hewlett-Packard (HPQ Note: HP is no longer a Dow-30 component). As regular readers may recall, the diversified computer, software, and services company suffered a 44.7% decline in 2012, as large write-downs resulted in steep losses for the second half of its fiscal year (ended October 31, 2012). Although the company’s earnings did not stage a full recovery in fiscal 2013, investors apparently responded positively to H-P’s progress as management carried out its “fix-and-rebuild” initiatives.

H-P wasn’t the only stock that produced an exceptional advance. DuPont (DD - Free DuPont Stock Report) posted an enviable gain of 44.4%, as the diversified chemical manufacturer benefited from strong performance among several of its business lines, including Performance Materials, Electronics & Communications, and Safety & Protection.

General Electric (GE - Free General Electric Stock Report) also boosted the Dogs’ overall performance, with an increase of 33.5%. The technology and financial services company successfully offset declining revenues through a combination of about $2 billion in cost cuts and contributions from several commercial acquisitions. Meanwhile, shares of global healthcare conglomerate Johnson & Johnson (JNJ -Free Johnson & Johnson Stock Report) were up 30.7%, as investors appeared encouraged by continued strength in the company’s Pharmaceutical division. Elsewhere, integrated circuit manufacturer Intel (INTC - Free Intel Stock Report) was up 25.9%, likely aided by improved earnings comparisons in the second half.

Overall, telecom giant AT&T (T - Free AT&T Stock Report) was the only one of the pack that did not show a double-digit gain for the year, rising 4.3%. But, after factoring in its Dow-leading 5% yield, it could hardly be called a bad year. The table below shows how all of the 2013 Dogs of the Dow stacked up.

Dogs of the Dow Price Increases:

Company

Ticker

Percent Change

Hewlett-Packard

HPQ

96.4%

DuPont

DD

44.4

General Electric

GE

33.5

Johnson & Johnson

JNJ

30.7

Intel

INTC

25.9

Merck

MRK

22.3

Pfizer

PFE

22.1

Verizon

VZ

13.6

McDonald’s

MCD

10.0

AT&T

T

4.3

 

A Few Changes For The New Year

One of the several attractive characteristics of the Dogs of the Dow strategy is that it requires little effort to carry out. You simply put an equal dollar amount in the 10 highest yielding of the 30 Dow Industrial stocks and hold onto them for a year. No need to constantly monitor the holdings or do any frequent trading. This both cuts down on research time and brokerage commission costs. Then, at the end of the year, the process is repeated.

The list for 2014 is largely unchanged from last year. Hewlett-Packard is, of course, out of the running since it was removed from the Dow in September. We also bid adieu to DuPont and Johnson & Johnson, but it’s not a tearful farewell, since their departures are largely due to the solid gains they posted last year, which lowered their relative dividend yields.

Replacing them we have Chevron (CVX - Free Chevron Stock Report), the world’s fourth-largest oil producer, Cisco Systems (CSCO - Free Cisco Systems Stock Report), a leading provider of Internet Protocol-based networking products, and software giant Microsoft (MSFT - Free Microsoft Stock Report). The table below lists the Dogs of the Dow for 2014 and their respective yields at the end of the year.

 

Here’s how the new Dogs stacked up in terms of yields at the end of 2013:

Company

Ticker

Yield

AT&T

T

5.2%

Verizon

VZ

4.3

Merck

MRK

3.5

Intel

INTC

3.5

Pfizer

PFE

3.4

McDonald’s

MCD

3.3

Chevron

CVX

3.2

General Electric

GE

3.1

Cisco Systems

CSCO

3.0

Microsoft

MSFT

3.0

 

Can The Dogs Repeat In 2014?

One of the cornerstones of the Dogs of the Dow strategy is its modest leaning toward a contrarian or value investing approach. That is, if a Dow stock has underperformed in one year, it will be more likely to find itself among the following year’s list of top-yielding components. And, being a well-established blue chip company, it’s more likely than not to recover.

Naturally, the telecom giants AT&T and Verizon (VZ - Free Verizon Stock Report) are very nearly permanent members of this club, mainly by virtue of their historically above-average yields. By the same token, some stocks, like recent Dow newcomers NIKE (NKE - Free Nike Stock Report), Goldman Sachs (GS - Free Goldman Sachs Stock Report), and Visa (V - Free Visa Stock Report), would have to see their share prices cut by over 50% (or their dividend payouts doubled) before they would even be in the running to make the Dogs list.

Unlike 2012, with its aforementioned 44.7% drop in Hewlett-Packard’s stock, the generally rising equity tide of 2013 lifted nearly all blue-chip boats. In fact, the only negative performer among the Dow Industrials was International Business Machines (IBM - Free IBM Stock Report) which shed 2.1% in market value for the year. But this was hardly enough to budge its yield much above 2%.

So, with no true underdog/turnaround story to root for in 2014, can the Dogs outperform the Dow for a second year in a row, and make it four out of the last five? That, of course, is anybody’s guess. But with the equity markets at historical highs, a repeat performance of 2013’s impressive returns certainly seems unlikely. After all, 2013 was the DJIA’s third-best year since 1975.

There are several factors working in the Dogs’ favor, however. For one thing, they have their traditional yield advantage over the other Dow components, which gives them a slight edge in terms of total returns. (Income investors, take note: On average, we look for the 10 Dog stocks to increase their dividend payouts by nearly 8% in 2014.)

This year’s lineup is also appealing in terms of another popular valuation measure. Specifically, the current Dogs started the year with an average Price/Earnings ratio of 14.6, compared to 17.4 for the rest of the Industrials. Lastly, fully half of this year’s mutts are currently ranked favorably for year-ahead relative price performance by our Timeliness Ranking System. By comparison, only two of the 20 excluded Dow Industrials hold that distinction.

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