I traditionally never like any of these “canned” ways to buy stocks. The reason that I don’t like them has nothing to do with their effectiveness (some of them may have merit), but it is more to do with what happens when they do prove to have any kind of validity (i.e. everyone follows them, and the reason why they were a good deal becomes non-existent).
I do like to watch the Dogs of the Dow, however, as this often a way to find a decent company at close to its Maximum Historical Dividend Yield, which often is a great long-term entry point. One does have to be careful, however, as even though these are established companies, there are often ones that are "Dogs" for a good reason. A case in point is if one were to follow this rule a couple of years back, you would have ended up with General Motors stock….
So, what are the Dogs of the Dow, as of November 13, 2009:
- Verizon (VZ) – 6.3% Dividend Yield
- AT&T (T) – 6.2% Yield
- DuPont (DD) – 4.8% Yield
- Merck (MRK) – 4.6% Yield
- Kraft (KFT) – 4.3% Yield
Verizon and AT&T
Telcos have traditionally been quite popular with many institutional investors, as well as the “Widows and Orphans” crowd, namely due to their strong cash flows and defensive nature. It makes sense, as even during the time of recession, one of the last things that you are going to cancel is one of your communications lines. However, it doesn’t mean that these businesses are without their faults. Communications networks are extremely capital intensive, and due to the fast moving nature of technology, especially 3G and 4G wireless, they always seem to be in need of billions of dollars in capital spending. As well, as the US market begins to become a bit more saturated with various communications offers, ARPU (average revenue per user) becomes more difficult to rise year after year.
Verizon does appear to be fairly cheap here, trading at about 12x expected 2009 earnings. When you factor in a 6.3% yield, this one should be a slam dunk, right? However, the market is favoring growth stocks, and Verizon does not seem to have a lot of immediate growth potential at the moment. Analysts are calling for less than 5% annual earnings growth over the next 5 years. The other issue in my mind is that the payout ratio is well over 70%, and in a capital intensive business such as telecom, there may not be room to raise the dividend anytime soon. Personally, I would want to see a catalyst that would move up Verizon’s earnings at a faster rate before having a lot of interest (such as maybe a hot device such as the iPhone??). Overall, this is a company that should be front of mind for many yield hungry investors only….
AT&T would have many of the same issues as Verizon, but does appear to have a little more upside. Their dividend payout ratio, while still relatively high, is a bit lower than Verizon. As well, although this isn’t going to be a “high-flyer”, analysts are looking for it to grow at a faster rate than Verizon over the next 5 years. It trades at a slightly higher multiple than Verizon (about 13x 2009 earnings), but it appears like the better buy at the moment. Having the iPhone on your network will do that, I guess!
DuPont is a great company, but I wonder about the timing. DuPont got hammered during the economic downturn, falling well over 50%. This is understandable, since much of their earnings are tied into very economically sensitive operations, such as chemicals and manufacturing. So…is it too early in the cycle for DuPont and is their dividend safe?
It is currently trading at about 17x 2009 estimated earnings, so in my opinion, there is a lot of upside baked into this stock already. Mind you, these earnings estimates have been rising dramatically, so perhaps they just haven’t caught up. Either way, I would proceed with a bit of caution on this one. Their payout ratio is still high, and I am not sure how fast many of the factories will come back on line. I would look for a lower entry point, probably down in the $28 range, which would be about 13x 2010 estimated earnings.
I traditionally have stayed away from pharma stocks, namely since I don’t have the foggiest idea how to read some of the reports about their upcoming drugs. For most of us, we don’t have enough medical and chemical knowledge to understand the implications (or potential upside) of many upcoming medications. So, I tend to stay away, with only a small investment in JNJ.
However, I have always admired Merck, as they seem to one of better long-term performing companies in this space. From a strictly financial standpoint, there is a lot of like about Merck. Their payout ratio is reasonable, they have over 22 billion on their balance sheet, and they have a great Return on Equity. Their growth expectancy is not mind-boggling, but they should be able to buy back shares to push the total return north of 10% annually for a long time.
At 10x 2009 expected earnings, Merck seems to have priced in much of the potential downside that might arise from any new healthcare plans, at least in my opinion. Merck looks like a decent entry point here….Perhaps following the health care bill news may prove fruitful, as there may be some scared investors who flee this space.
I may not be smart enough to understand Merck’s products, but I certainly know Kraft’s! Kraft has a long track record of steady growth, and is an easy to understand business, which is probably why it got the attention of Warren Buffett, one it their shareholders. Kraft’s business lines are relatively defensive in nature, although one always has to worry about the store-brands from places like Kroger (KR), which have gained traction during the economic downturn. As well, I am always keeping an eye on input costs, namely sugar and wheat, which may rise partly due to demand and also partly due to a falling US dollar.
Speaking of the dollar, Kraft (along with companies such as Coca-Cola (KO)) can see some increased international sales due to a falling US Dollar in the future, which may be one of their appealing characteristics. I also like Kraft’s international growth potential.
Steady earnings, some International upside growth and strong brand loyalty are great characteristics for a company as an investment, but you rarely find them at a incredible bargain. This can be said for Kraft, although its multiple of 13-14x expected 2009 earnings doesn’t seem excessive. Personally, I would be cautious on this one, until I got a better understanding of what they may do next with Cadbury (CBY). This may provide a lower entry point, perhaps in the $23 to $24 range, at which I would consider Kraft to be a strong buy.
Disclosure: No position in any of the 5 stocks that this article is based on. Long on Coca-Cola and Johnson and Johnson.