Tuesday, 12 June 2012

Dogs of the Dow?

As we get quite a few American readers on this site I thought we should take a look at some American stocks. Even for British investors American stocks can be worth adding to their portfolio although most brokers usually charge a bit more to trade international stocks.


What are the Dogs?

The Dogs of the Dow as many of you will know is an investment strategy based on buying the highest yielding stocks in the Dow Jones Industrial Average Index. Historically this has outperformed the market. There have been abusive variations on this strategy including the foolish four which was a case of pure data mining.

As you are probably aware the dividend yields in the USA are not as generous as those in the UK or Europe. For this reason we will just review the top 5 yielding Dow stocks at present:

Johnson & Johnson

At 5% AT&T's dividend is quite generous but by the time you get to Johnson & Johnson in 5th place you're getting less than 3.5%. Also not much diversity with two telecoms giants, two pharmaceutical giants and a health care products giant. Certainly all giants though with market capitalisation's well over $100 billion each.


The average 3 year dividend for AT&T has been $1.69 a year giving us an average 3 year yield of 4.9%. The dividend has been increasing by 4c a year for the last 3 years. Analysts forecast a dividend of $1.81 in two years time giving an annual dividend growth rate of 2.3%. Using our standard valuation method we get a growth rate of 0.9% and an adjustment rate of -0.6% based on an historic yield of 5.5% this gives us an expected return of 5.22% a year.

As you can see the share price has been performing very well this year after its 100 day break out in December 2011. Investing at the breakout of $30 a share the expected return would have been a more impressive 6.7%. Looks like we missed this one.


The second communications giant in the list is Verizon. Almost a carbon copy of AT&T, a steadily rising dividend with similar growth forecasts, $2.07 in two years from $1.97 today, gives 2.3% annual growth. The dividend yield is a bit lower and the 3 year average is 4.5%. The lower yield gives us a higher adjustment rate of -1.0%. Total expected return: 4.48% a year.

Again a fairly similar chart. It broke its 100 day high a bit earlier in the beginning of December 2011. Again looks like we missed a lot of the value. Investing at $38 on the breakout would have given a 5.56% expected return. Not quite as attractive as AT&T. Interestingly the pull back to $37 in April this year would have produced a 5.8% expected return. 


Moving down the list we get to a pharmaceutical: Merck. A stable $1.52 dividend for each of the last 3 years. Analysts forecast a $1.73 dividend in 2 years time giving a generous 6.6% annual dividend growth. The current 4% dividend gives an adjustment of -1.6%. Total expected return is 4.97% a year.

Again positive price action, the uptrend seems to be slowing but for now the 100 day low is supporting well.


Another pharmaceutical. This one has the best dividend cover of all the stocks in the list with almost 3 at present and 2.5 forecast. The dividend has been a bit shaky going from 80c to 72c and then back to 80c. Forecast for 2 years time is 94c a share giving a very optimistic growth rate of 8.3% a year. The lower dividend yield gives us a higher adjustment rate of -2.2% a year. Total expected return: 4.57% a year.

Again another impressive uptrend. 

Johnson & Johnson

Finally we have Johnson & Johnson. Current yield is 3.35% and the average 3 year is 3.1%. The dividend has been rising quite rapidly. Current dividend is $2.11 and the forecast for 2 years from now stand at $2.38 giving a respectable 6.2% annual dividend growth. the relatively low dividend gives us a highish adjustment rate of -2.8%. Total expected return a rather mediocre 2.72% a year.

The chart for this one doesn't look very promising either. The 100 day low has recently been broken and it looks like there is a good possibility of a downtrend starting.


The table below gives a summary of the figures used in the above calculations:

3yr Yield
Total Return
Johnson & Johnson

One thing that might be striking is the very conservative growth rates used in the predictions. Remember we use 40% of the analysts rate to give us a margin of safety. Still with rates below 1% on AT&T and Verizon and the other stocks with rates not much higher than inflation the total return calculations are on the conservative side.

None of the stocks is screaming "Buy" at the moment, none of them look particularly overvalued either. When AT&T was at $30 in April (and still on an uptrend) the expected return was a much more appealing 6.7%. Maybe waiting for a buying opportunity could be the best course of action here

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