Dow's Best Value Plays in 'New Normal' Economy

• ByJake Lynch, TheStreet.com Ratings Investment Analyst
• On 5:00 am EST, Tuesday November 3, 2009

BOSTON (TheStreet) -- On Sept. 21, I suggested investors may do better with blue-chip stocks than with small-caps. Since then, the Russell 2000, a barometer for small-company shares, has dropped 9%, while the Dow Jones Industrial Average of the 30 biggest U.S. companies has remained flat.

Investors typically have been willing to pay a premium for growth stocks, those with the fastest earnings increases. But in a new normal economy, marked by banks' unwillingness to lend and consumers' newfound tightwad posture, investors will pay a premium for safety. These days, the best investments are established companies with international diversification and brand power.

Sifting through oodles of large-cap stocks can be draining, so here are three Dow members that offer compelling value and hefty payouts. They receive less attention than the rest of the pack, but are likely to achieve growth even if the economy struggles.

I have remained wary of AT&T over the past six months, not due to fundamentals such as revenue or earnings potential, but because of nagging fears the company will lose its iPhone exclusivity withApple. Those concerns are, so far, unwarranted.

AT&T's third-quarter profit declined marginally to $3.2 billion, or 54 cents a share, as revenue decreased 2% to $31 billion. AT&T's gross margin remained steady at 58%, but its operating margin slipped from 18% to 17%. The company garnered an extra 2 million wireless subscribers, the highest-ever third-quarter gain.

The wireless churn rate, a measure of customer turnover, fell to a low of 1.2%. TheStreet.com Ratings gives AT&T a financial-strength score of 8.3 out of 10, higher than the "buy"-list average of 7.1. The stock offers a dividend yield of 6.4%, more than twice the S&P 500 Index average of 2.8%. A payout ratio of 81% indicates dividend safety.

AT&T sells at a trailing price-to-earnings ratio of 13, a modest discount to integrated telecom peers. The stock is 14% cheaper than its peer group based on projected earnings and 85% cheaper based on book value. AT&T has fallen 10% this year, underperforming major U.S. indices.

Chevron is looking more attractive than rival Exxon Mobil these days. Both companies reported disappointing quarterly results, with revenue and profit falling precipitously. But Chevron is cheap and, like AT&T, rewards investors with a sizable dividend.

Chevron's third-quarter profit dropped 50% to $3.8 billion, or $1.92 a share. By comparison, Exxon Mobil's plummeted 68% to $4.7 billion, or 98 cents a share. Despite Chevron's comparative outperformance, its shares are cheaper than those of Exxon Mobil on the basis of trailing earnings, projected earnings and sales per share. More broadly, Chevron is 32% cheaper than integrated oil and gas peers on the basis of trailing earnings and 55% cheaper on the basis of projected earnings, an alluring value proposition.

The stock pays a 3.6% dividend yield, higher than the 2.8% average of S&P 500 companies and the 2.3% yield offered by Exxon Mobil. Chevron has a payout ratio of 44%, so its dividend has ample room to grow. The stock has advanced just 4% this year, lagging behind major U.S. indices.

Insurance titan Travelers has rebounded from the throes of recession. Third-quarter profit surged more than four-fold to $935 million, or $1.65 a share, as revenue grew 3% to $6.3 billion. The company's gross margin rose from 21% to 35% and its operating margin climbed from 5% to 21%.

Since the year-earlier quarter, Travelers has boosted its cash balance 24% to $6.8 billion while debt grew just 3% to $6.5 billion. The company's balance sheet now has a liquid tilt. And its debt-to-equity ratio of 0.2 is below the insurance-industry average, demonstrating restrained leverage.

Although the company's 2.3% dividend yield is unremarkable, its shares are cheap. Travelers sells at a price-to-earnings ratio of 9, a substantial discount to the market and property-and-casualty insurance peers. The stock is 67% cheaper than peers on the basis of trailing earnings and 23% cheaper on the basis of projected earnings.

Travelers has advanced 13% this year, more than the Dow, but less than the S&P 500. The company is boosting profitability by cutting costs, strengthening its durable balance sheet in the process. Those are signs of near-term profit growth and long-term operational discipline.

-- Reported by Jake Lynch in Boston.

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