The Dogs Of The Dow Get Off To A Sluggish Start In 2015

Includes: CAT, CVX, MRK, PFE
by: Value Line

The year got off to a slow start for The Dogs of the Dow, with an equally-weighted portfolio of the 10-highest yielding Dow stocks at the close of 2014 falling.

Two of the dogs did manage to finish the month in positive territory: Merck rose 6.1% to take home the top prize, while Pfizer inched ahead 0.3%.

Concerns about the global economy and declining commodity prices appeared to be too much for the other dogs, particularly Caterpillar and Chevron.

By Robert M. Greene

The year got off to a slow start for The Dogs of the Dow, as these stocks had limited success overcoming the headwinds in the broader equity markets. In all, an equally-weighted position in the 10-highest yielding Dow stocks at the close of 2014 would have fallen 3.4% for the month. By comparison, the Dow Jones Industrial Average declined 3.7% in January, while the S&P 500 Index fell 3.1%.

Running Against the Pack

Only two of the Dow dogs managed to finish the month in positive territory, and both came from the drug industry. Merck (MRK) took the lead. (Note: Among the entire Dow 30, its performance lagged only behind Boeing (BA), which advanced 11.8%.) The stock's strong performance marked a nice rebound from the difficult month of December. MRK shares were in strong demand for most of 2014, but fell 5.3% in the final month of the year, as investors cast a wary eye on the company's proposed acquisition of Cubist Pharmaceuticals. That addition would provide a jolt to the company's faltering top line, which has declined each of the past three years. The deal would likely have little impact on 2015 earnings, but ought to be significantly accretive in 2016 and beyond. The announcement of the acquisition in early December, though, was followed only hours later by news that a judge had ruled that two key patents on Cubist's top-selling drug Cubicin were invalid.

The only other dog to behave itself in January was Pfizer (PFE); although its stock price finished the month just $0.10, or 0.3%, above where it started the year. Much like Merck, the company has been struggling with patent losses on blockbuster drugs. Sales, in fact, have declined every year since 2011. On the positive side, two top-grossing franchises have been making healthy strides (sales of LYRICA and PREVNAR rose 14% each last year), but this probably won't be enough to halt the company's top-line slide in 2015, with foreign-exchange headwinds likely adding to Pfizer's other challenges. Against this backdrop, many investors appear to be looking for acquisitions and businesses development deals to help get the drug giant back on track. The company failed last year in an attempt to buy AstraZeneca (AZN), but it continues to have ample financial firepower to remain a big player on the M&A front. In the meantime, Pfizer has been putting its cash to work repurchasing stock, spending about $5 billion last year on share buybacks.

Taken to the Pound

Caterpillar (CAT) stock dropped 12.6% in January, making it the worst performer among the Dow dogs. It was the only one among the 10 dogs to suffer a double-digit decline, though four of the other components of the Dow 30 shared this dubious distinction. The release of the company's December-quarter results, which showed a 15% earnings decline, and management's rather dour commentary regarding 2015 contributed significantly to this equity's difficult month. Indeed, Caterpillar indicated that a lackluster global economy and depressed commodity prices would likely cool demand for its heavy equipment. In all, the company expects an 8%-10% decline on the top line and an even more pronounced drop in earnings this year.

Elsewhere, Chevron (CVX) saw its stock price decline nearly 9% during January. The collapse in oil prices since last summer remains the key catalyst driving this stock. (Shares of ExxonMobil (XOM), another Dow dog, fell 5.4% for the month.) Even with its partial rebound in February, crude oil is still off about 50% from its 52-week high. The challenging operating environment will likely cause earnings to fall sharply this year. The company, like many of its industry peers, is responding by cutting back on capital spending. With its very strong balance sheet, Chevron shouldn't have to do the same to its quarterly dividend, which has increased every year since 1988.

Notwithstanding with the sluggish start to 2015, a Dogs of the Dow strategy is likely to appeal to some investors, particularly conservative, income-oriented accounts. Among this year's pack, most are lauded for their stability and relatively low Betas. (Caterpillar and General Electric (GE) do carry slightly higher levels of volatility.) Too, this group offers an average yield in excess of 3.5%, well above the current 2.0% median for all dividend-paying stocks in the Value Line universe.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.