Digging Through The Dow For Yield And Value

by: Plan B Economics

Investment managers worldwide are overweighting US large cap stocks within the equity components of their portfolios (even if they are underweighting stocks in general). This is because US large cap stocks are seen to be relative 'safe havens' when compared to the dogs in Europe and the unknowns in emerging markets. (Of course, US stocks could lose money just like any other stocks around the world.)

Portfolio managers are also turning to US large caps for their relative value compared to the pitiful yield on US Treasuries (the 10yr US Treasury currently yields 1.78%). Even investment grade corporate bonds only yield about 150bps more than the dividend yields on many similar equities (compared to earnings yield, the spread is even less). For 150bps in yield give-up, you get potential dividend growth and potential capital appreciation. In fact, many long-term investors simply buy dividend-paying stocks for an indefinite, growing income stream, ignoring the fluctuations of their initial capital.

With this in mind, yesterday evening I spent some time scouring through the big cap components of the Dow Jones Industrial Average and I liked what I saw...single-digit p/e ratios, 3-4% dividend yields. Who would have ever thought that Microsoft (NASDAQ:MSFT) would trade at 9.4 times earnings with a 3.20% dividend yield! (Take a look at the table below.)

Many of these companies are the stalwarts of the American economy, but are also global mutinationals. Many of these companies also have a rich history of paying and growing dividends, partly because of their pricing power, size and competitive prowess.

OK, enough with the praise. Let's be realistic - it appears like we're in a bear market and these already cheap stocks could get cheaper. On the other hand, who really knows where the market is going over the next couple months? I can make informed forecasts, but there are so many exogenous variables that any prediction is still an exercise in probability.

What would I do next?

1. First, I'd pick out a few of the lower p/e (below 12), higher yield (above 3.2%) stocks such as: CVX, DD, GE, INTC, JPM, MSFT, T, TRV and V. Interestingly, this selection happens to cross a range of industries, which helps diversify risk (to an extent - they are all still exposed to systematic risks). While each of these companies has its pros and cons, enough of the downside has been taken out already so that investors don't need to get caught in a cycle of analysis paralysis. I consider the approach of identifying stocks that meet specific criteria (e.g. low p/e, high dividend yield) an 'enhanced indexing strategy'. Buy enough stocks that meet a specific objective criteria and an investor has created a customized, enhanced index. As the theory goes, once an index holds anywhere from 15-30 stocks across a range of industries it has essentially eliminated idiosyncratic risk, leaving systematic risk that hopefully matches the investor's target beta. Of course, in this case only nine fit the criteria so I would only consider this a portion of a diversified enhanced equity index.

2. Second, since I don't want to try and time the bottom but I want to participate in the upside, I would put small amounts of money to work over time (i.e. I would dollar cost average into these positions). The objective of dollar cost averaging is to start putting money to work while lowering average costs if stocks continue to decline. The downside of this execution strategy is if stocks enter into a new bull market tomorrow - if this were the case, spreading investment over a period of time reduces participation in the upside. A dollar cost averaging strategy is for someone that is unsure about the market direction.

Company / Ticker P/E % Yield
Alcoa (NYSE:AA) 10.43 1.30
American Express (NYSE:AXP) 11.28 1.60
Boeing (NYSE:BA) 12.51 2.80
Bank of America (NYSE:BAC) n/a 0.70
Caterpillar (NYSE:CAT) 12.00 2.50
Cisco (NASDAQ:CSCO) 13.32 1.50
Chevron (NYSE:CVX) 7.99 3.40
EI Dupont de Nemours (NYSE:DD) 11.15 4.10
Disney (NYSE:DIS) 12.66 1.30
General Electric (NYSE:GE) 11.69 3.90
Home Depot (NYSE:HD) 14.63 3.00
Hewlett Packard (NYSE:HPQ) 5.40 2.10
International Business Machines (NYSE:IBM) 14.19 1.70
Intel (NASDAQ:INTC) 9.74 3.90
Johnson & Johnson (NYSE:JNJ) 14.87 3.60
JP Morgan Chase (NYSE:JPM) 6.46 3.30
Kraft Foods (KFT) 18.78 3.50
Coca Cola (NYSE:KO) 12.15 2.80
McDonald's (NYSE:MCD) 17.50 3.20
3M Company (NYSE:MMM) 12.23 3.10
Merck & Company (NYSE:MRK) 33.78 4.60
Microsoft (MSFT) 9.42 3.20
Pfizer (NYSE:PFE) 16.42 4.50
Proctor & Gamble (NYSE:PG) 16.12 3.30
AT&T (NYSE:T) 8.24 6.00
The Travelers Companies (NYSE:TRV) 9.09 3.40
United Technologies (NYSE:UTX) 13.47 2.70
Verizon Communications (NYSE:VZ) 16.33 5.40
Wal-Mart Stores (NYSE:WMT) 11.26 2.80
Exxon Mobil (NYSE:XOM) 9.60 2.60
Click to enlarge

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.