Dogs of the Dow: Can One Match H-P’s 50% First-Quarter Gain?

Investing in the Dogs of the Dow is one way for yield hungry investors to get their hands on some of the excess cash that corporations have had sitting on their books for years -- and in the first quarter, at least, it has also proved to be a very lucrative one. The Dow Jones Industrial Average soared more than 11% during the first three months of 2013, while the 10 stocks that at the end of 2012 offered the highest yields from amongst the 30 in the Dow soared 16.7%, with “Dog” Hewlett Packard (HPQ) leading the way with a gain of about 50%.

That gain was enough to transform the still-struggling PC manufacturer into a rather chintzy-looking dividend payer in comparison to its fellow canines, with a dividend yield of only 2.43%, tossing it out of the group altogether as of the end of the quarter. Gone, too, is Johnson & Johnson (JNJ), which rallied 15.8% during the period and now offers a dividend yield of 3.02%.

But there are a handful -- or pawful -- of companies in the Dow worth a second look at the beginning of the second quarter of 2013. These include the two companies from within the ranks of the original “Dogs” that have posted the most anemic returns relative to the broader index -- Intel (INTC) and DuPont (DD) -- and the two companies that replace Hewlett Packard and Johnson & Johnson on the list, Microsoft (MSFT) and Chevron (CVX).

^DJI Chart

^DJI data by YCharts

These aren’t the dogs that offer the fattest yields: their payots pale in comparison to the 4.77% dividend yield generated by AT&T (T) or the 4.2% dividend yield provided by fellow telecommunications giant Verizon (VZ). But they are cheaper -- often significantly so -- and although they make up part of some of the market sectors that analysts expect to struggle most to generate earnings growth in the coming quarters, they may still offer some upside for value investors who are focused on yield. All four have lagged the Dow’s 11.25% first-quarter advance, while Verizon outperformed it, rallying 13.59%. Even though AT&T continues to lag the broader index, it still commands a PE ratio of more than 30, based trailing earnings.

DD Dividend Yield Chart

DD Dividend Yield data by YCharts

All four companies, of course, face headwinds or must grapple with strategic challenges to their business. But in all four instances, there are reasons why an investor with a solid understanding of the company’s fundamentals and the risk associated with the investment might find the company intriguing.

Perhaps two of the most surprising companies to find among the Dogs are Intel and Microsoft: it hasn’t been all that long since these were among the highest-growth blue-chips in a high-growth industry. And if investors feel comfortable betting on Hewlett Packard, why not Microsoft? True, like Hewlett Packard, Microsoft is experiencing the kind of competitive challenges (in its case, from the likes of Apple (AAPL) and Google (GOOG) that it has never experienced previously, and some analysts argue it has fumbled attempts to rebuild its franchise with Windows 8; certainly, analysts have been trimming their earnings estimates for the company. But there’s an argument for scooping up this stock at the bottom of a cycle, as there is for Intel, which is battling to gain significant market share in the mobile space against rivals like Qualcomm (QCOM). Intel needs to win the backing and confidence of vendors like Samsung, and that won’t be simple. But these are two stalwarts of the technology arena, trading at forward multiples of earnings that are close to their recent lows and well below the average multiple for the S&P 500 of just north of 14.

MSFT Forward PE Ratio Chart

MSFT Forward PE Ratio data by YCharts

The same is true for the other two intriguing Dows of the Dog, both dinged by a combination of macroeconomic trends that have affected pricing and margins on their key products. Both DuPont and Chevron must live within the constraints of global prices for their goods: in DuPont’s case, chemical products of various kinds, and in Chevron’s, oil prices.

Dupont, which currently offers investors a dividend yield of 3.53%, is in the midst of what some bulls on the stock have described as a turnaround. It has sold its lower margin performance coatings business to Carlyle Group in order to focus on the higher-growth agricultural business, including seed and crop protection products that farmers likely will consider more valuable and worth the higher prices in the wake of last summer’s drought. Part of the after-tax proceeds of the sale of the coatings business will be used to finance a $1 billion share buyback program, DuPont noted. Meanwhile, Deutsche Bank is among bulls, having suggested that the company’s stock could hit $55 a share (from about $48.35 currently).

Chevron is a trickier nut to crack. Although its PE ratio is only 8.76, and it offers a dividend yield of 3.06% --- not to mention minimal debt and large cash positions that suggest that the company will be able to increase that payout level over the coming quarters even as it continues to boost its capital spending -- there remain some big uncertainties hanging over the company’s head. The largest of these, of course, are commodity prices, which dictate its profit margins. But Chevron has faced a number of operating problems: a blowout at its Nigerian operations; a leak in Brazil; and a long-running and high-profile lawsuit in Ecuador revolving around the contamination of rainforest that is home to many indigenous peoples in the region.

Clearly, the Dogs are dogs for a reason. But as Hewlett Packard’s first-quarter performance demonstrated, they can offer tremendous upside potential, if only for traders and investors with a shorter time horizon. Even if you don’t like these four stocks, it’s worth scanning the list or even deciding to make a “Dogs” investment strategy part of your portfolio. Few Dow components are likely to be teetering on the edge of filing for bankruptcy and it could be argued that Hewlett Packard’s graduation from the Dogs means that -- as a group -- the dividend yields of the remaining members now are safer than they were before. As the market has rallied so much this year, odds are that the emphasis on yield, wherever it can still be located, is only going to increase.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.

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