Many investors are searching for higher-yielding equities. The interest rates most banks now offer for cash and CDs are barely negligible, as are short-term U.S. Treasury rates. Generally speaking, U.S. debt's no longer considered the risk-free asset that it historically was, and many investors are avoiding all bonds until higher interest rates arrive.
Certain equities may help investors find not only an income option but also the potential for some decent capital appreciation. The S&P 500 average dividend is currently approximately 1.7%, and the Dow Jones Industrial Average is yielding about 2.33%. These yields correspond to U.S. Treasuries in the three-to-five-year range. One popular method of obtaining both above average equity yield and capital appreciation is known as buying the Dogs of the Dow, or those Dow Industrial members that have the highest yields. I previously identified the 10 highest-yielding Dow Industrial members
and wanted to test the Dogs of the Dow theory thus far in 2011. I removed the initially lowest- and highest-yielding members from the list (a standard statistical technique) and prepared charts of their corresponding valuations over the short- and mid-term. The resulting list then included, listed in alphabetical order:
Intel Corporation (NASDAQ:INTC) Yield: 3.3%
Johnson & Johnson (NYSE:JNJ) Yield: 3.42%
Kraft Foods Inc. (KFT) Yield: 3.34%
McDonald's Corp. (NYSE:MCD) Yield: 3.01%
Merck & Co. Inc. (NYSE:MRK) Yield: 4.2%
Pfizer, Inc. (NYSE:PFE) Yield: 3.8%
Procter & Gamble Co. (NYSE:PG) Yield: 3.16%
Looking back at them, these dogs have no fleas.
Over the last two years, this group has performed reasonably well. As the chart below shows, each of these stocks gained between 20% and 40% over the term, not counting their dividends. This appreciation is below the average return for the broader market over this period, but these companies also depreciated less than the average during the most recent financial crisis (and may very well do so during the next one, whenever it occurs).
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Since the start of 2011, these dogs also performed reasonably well. The group appreciated between 2% and 20%, compared to a 5% gain in the lower yielding S&P 500.
Further, the dogs have begun to noticeably outperform the S&P 500 in the short term. As the three-month chart shows, this group is up between 2% and 12% over the period, though the S&P 500 is flat for the quarter.
The relatively consistent growth in both market value and dividends provided by these dogs appears to be a growing choice for investors. Another possibility is that these larger companies that produce well-known products and brand names are more resistant to market downturns due to the relative safety of their products.
These companies have pricing power and a long-term history of surviving rough economies, recessions and periods of increased inflation. Due to these characteristics, it appears likely that these dogs will provide a preferable margin of safety than the broader market, and have done so within the volatile first half of 2011, while providing investors with dividends at or above the present five-year Treasury rate.