Our 5 Favorite High-Yield Dogs of the Dow

Includes: INTC, JNJ, MDLZ, PG, T
by: Investment Underground

By Eli Inkrot

“Dogs of the Dow”: Doesn’t quite have that appealing ring to it does it? But don’t judge this strategy just yet. The ‘Dogs of the Dow’ method suggest that an individual looking for quality, high yield stocks should invest in the ten highest yielding stocks in the Dow Jones Industrial average. While some might profess that high yield leads to high risk, it must be remembered that you’re picking from a very tight basket of well established companies. If a company drops from the top ten, you replace it the next year. In today’s market this can occur often, as the gap between the average DJI stock yield, 2.75%, and one of the “dogs”, 3.8%, has begun to close. Just as the Dow is selective in choosing and losing companies, we’re selective in picking the winners amongst the highest yielding ones. Here are our Favorite Dogs of the Dow.

Coming in with the highest yield on this list and thereby earning the title of “Top Dog” is AT&T (NYSE:T). This Dallas-based telecommunications giant has a well above average current yield of 5.53%. Recently T was ranked as the 12th largest company in the Fortune 500 and third in the state of Texas behind oil’s Exxon Mobil (NYSE:XOM) and ConocoPhillips (NYSE:COP). If the move to acquire T-Mobile (OTCQX:DTEGF) goes through AT&T could be eyeing a place in the top 10 sooner rather than later.

But to be a favorite you have to appear more attractive than the competition right? Well AT&T has to look no further than the current DJI dog number two, Verizon (NYSE:VZ). Just as important as a high yield, likely much more important, is the ability to sustain the dividend payouts; after all, a cut dividend doesn’t help anyone. On the dividend scene, T looks to have VZ beat. Verizon has a more than respectable yield of 5.29% but still lags T’s 5.53%. AT&T has not only paid but also increased its dividend for 27 consecutive years at an average 10 year rate of just over 5 percent. Comparatively Verizon has only increased its payout for the last 6 years at an average 10 year rate of around 2 percent. Further T has a sustainable payout ratio around 50%, while VZ is approaching 100%.

AT&T has many upsides such as a high yield and long history of increasing payouts, but there still exist some caution flags. For example T has had a strong run in the last couple of months and is now very close to its 52-week high: 24 brokers come to a collective 1-year target upside of just 5%. It can be disheartening to know that you could have had a yield over 6% just 2 months ago, but then again T still leads the Dogs of the Dow.

With a 3.48% current yield Johnson & Johnson (NYSE:JNJ) has the 5th highest yield among the Dogs of the Dow. Sure, we leap-frogged fellow pharmaceuticals Pfizer (NYSE:PFE) and Merck (NYSE:MRK) but it wasn’t because we didn’t like their respective 3.89% and 4.12% yields. The real issue comes in with PFE’s recessionary dividend cut and MRK’s frozen dividend since 2004. After all everyone wants to see their stock price rise, but a simultaneous drop in dividend yield due to stagnant payouts could easily soften the excitement.

JNJ is all excitement and no stagnation as this New Jersey-based healthcare company has increased payouts for 49 consecutive years. A buy before earnings just two months ago would have lead to yield on cost nearing 4%, not to mention a 14% boost in share price. Still, the current yield around 3.5% is attractively above average, while 13 brokers see a median 1-year further upside of around 5%. The Price to Earnings ratio around 15 appears to be show fair value, while the 49% payout ratio suggests sustainability. In addition, Warren Buffett’s Berkshire Hathaway has 45 million shares and seems to be enjoying the 10 year average dividend growth rate around 13 percent.

From one Buffett holding to another we move to dog number 6, Kraft Foods (KFT). With a current price around $35, Buffett’s 97 million shares have only recently turned to gains from their $33 cost basis. This Illinois-based diversified food maker cracked the top 50 on the recent Fortune 500 list coming in at 49. With brands such as Kraft, Oscar Meyer, Maxwell House, Nabisco and Oreo it sure sounds delicious. The current yield of 3.32% is respectable, while the payout ratio around 68% is ok.

KFT has offered the same $.29 quarterly payout since September of 2008. I know, this stagnant dividend is the same type of thing that got PFE and MRK booted from the list, but to be fair KFT is comparatively new to the dividend game having made payouts for the last 10 years. Meanwhile, PFE has 30 years experience while MRK boasts about 40 years, yet they both have hit snags as of late. Additionally, KFT has increased payouts 8 times in the last decade. But the real reason that KFT makes the list is the Buffett power behind it. Not necessarily that it’s owned by Buffett, but more that it acts like a Buffett stock: Strong economic moat and pricing power. As is the story with many stocks today, KFT nears its 52-week high. 17 brokers look for a 1-year target upside of just 3%. Perhaps a buy but only on a price dip.

Coming in at number 7 on the Dogs of the Dow list is Santa Clara-based Intel (NASDAQ:INTC). Just 1 share bought in 1987 would have turned into 48 today, you know if you’re interested in multiplying your principle by 50. Long a growth story, this technology giant has recently turned itself into a value play. INTC comes in at 56th on the Fortune 500 list, cementing itself as the top semiconductor company. Just a month ago before earnings the stock was priced under $20, but has since increased about 16% nearing $23. INTC has a respectable current yield of 3.15%. INTC has been able to grow dividends for 8 consecutive years now, but perhaps most surprising is by how much. The average 10 year dividend growth rate is near 25% while recently it has been climbing in the low double digits. Sustainability doesn’t appear to be a problem either as INTC pays out just 36% of its profits. Sure you already missed out on a 16% gain, but analysts still like it as 37 brokers agree on a 1-year target upside of about 13% from here.

Finishing off our favorite Dogs of the Dow is mega staple Proctor & Gamble (NYSE:PG). This Cincinnati-based consumer goods company ranks 26th on the Fortune 500 list, which places it third amongst companies from Ohio and well ahead of other household and personal products leaders Kimberly-Clark (NYSE:KMB) and Colgate-Palmolive (NYSE:CL). With brands such as Olay, Pantene, Braun, Gillette, Crest, Oral-B, Dawn, Downy, Duracell, Gain, Tide, Bounty, Charmin and Pampers Proctor & Gamble is a giant in the diversified staples game. With this comes pricing power most recently seen in diaper price hikes. PG has a current yield of 3.13% and is beyond consistent with 55 straight years of increasing dividend payouts. Usually companies tend to slow their dividend growth rates as they age, but PG has been consistently growing its payouts around 10% for the last 10 years. If PG can keep this up for the next 10 years, that 3.13% current yield could turn into an 8% yield on cost. The payout ratio around 60% appears sustainable as it has been for the last 121 years. Buffett backed into this stock through his Gillette holdings and his 72 million shares have since multiplied by about ten, from a cost of about $460 million to today’s $4.8 Billion. Analysts like it to, as 20 brokers look for a median 1-year target upside of about 6% in addition to the recent run-up.

Disclosure: I am long T, PG.