Why Take Risks When Blue Chips Are on Sale?

Includes: DLN, JNJ, MRK, MSFT, PG, PM, T, XOM
by: Charles Lewis Sizemore, CFA

The market is a funny thing. Financial theory would tell you that in order to get a higher return you must accept higher risk by buying more volatile investments.

Most of the time, this is true. You’re not generally going to enjoy market-beating returns by buying established, staid Dow components. Blue chips are generally already so big that their best days of growth are behind them. Plus, because investors generally pay a premium for safety, they are usually priced too expensively to offer high returns.

Well, after three years of relentless volatility, we have some interesting anomalies forming. Some of America’s biggest and best companies are also among its cheapest.

This should not be. But it is true.

Let’s take two household names as examples. Johnson & Johnson (NYSE:JNJ) and Microsoft (NASDAQ:MSFT) both trade for 12 times trailing earnings, while the broader S&P 500 trades for 15.

This is madness. J&J and Microsoft are two of the four AAA-rated companies left in America. They are arguably better credit risks than the U.S. government, given the deficits being run these days. Yet their shares trade at a discount to the broader market.

Johnson & Johnson pays a dividend of 3.7%—substantially higher than the 10-year Treasury note’s yield of 2.7%—while Microsoft pays a more modest 2.1%. Unlike bond interest payments, however, Microsoft’s dividend is actually likely to grow in the coming years. A high and growing dividend means that investors get paid to wait for their investments to work out. And given that money in the bank yields practically nothing these days, the opportunity cost of forgoing bond or savings account interest is virtually nil.

We could cherry pick a portfolio of high-quality U.S. companies trading at discounts to the broader market, but we don’t have to. Jeremy Siegel and company have already done the hard work for us, putting together an off-the-shelf portfolio that suits our purposes perfectly: The WisdomTree Large Cap Dividend Fund (NYSEARCA:DLN), based on the index by the same name.

Per WisdomTree, the index is a fundamentally weighted index that measures the performance of the large-capitalization segment of the U.S. dividend-paying market. The index is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividend per share.

In other words, the companies in the fund are weighted according to how much cold, hard cash they return to their investors. The top holdings of the fund are a veritable “who’s who” list of solid American companies trading at discounts to the broader market: AT&T (NYSE:T), ExxonMobile (NYSE:XOM), Johnson & Johnson, Merck (NYSE:MRK), Microsoft, Philip Morris International (NYSE:PM), and Procter & Gamble (NYSE:PG).

Banks are conspicuously absent, and that is fine by me.

In a low-interest-rate environment characterized by the lingering threat of deflation, buying America's best dividend paying companies at a discount to the broader market is the prudent investment to make.

Disclosure: Long, DLN, JNJ, MSFT, T, MRK, PM, PG