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3 Dogs of the Dow That Will Turn Around

Luke Lango

There are a ton of investment strategies out there. Some are based on technicals and momentum. Others are based on fundamentals. But none are quite as widely accepted as the Dogs of the Dow investment strategy.

Popularized in the early 1990’s, the Dogs of the Dow investment strategy is to buy the Dow stocks with the highest dividend yields. It essentially operates on the assumption that Dow stocks are so good, and their companies are so big and powerful, that under-performance in any one Dow stock is a near-term phenomena that will correct itself and eventually turn into over-performance.

But that isn’t necessarily true.

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There has been a lot of turnover in Dow components recently. For example, back in the early 1990’s when the Dogs of the Dow investment strategy went mainstream, Eastman Kodak Company (NYSE:KODK) and Goodyear Tire & Rubber Co (NASDAQ:GT) were powerful Dow stocks.

Now, neither company is a part of the Dow, and both stocks have performed horribly in the two decades since the early ’90s.

As such, the Dogs of the Dow investment strategy should be taken with a grain of salt.

With that in mind, here’s a list of three Dogs of the Dow stocks with high yields that should be able to bounce-back in the near future.

Dogs of the Dow 1: Verizon (VZ)

Dogs of the Dow 1: Verizon (VZ)

Source: Via Flickr

Although the company has the highest yield of any stock in the Dow at 4.8%, telecom giant Verizon Communications Inc. (NYSE:VZ) actually hasn’t performed all that bad over the past year. VZ stock is up more than 6% over the past 12 months.

The Dow, though, is up 14% over the past year, so VZ’s 6% gain is actually underperformance.

The reason for the underperformance is that Verizon has been subject to ruthless pricing trends in the wireless carrier market. It seems that it has been a while since new technology has been infused into the wireless carrier market. Specifically, it seems like we’ve been stuck in the 4G/LTE coverage phase for a long time. This long pause in coverage innovation has allowed for smaller competitors to level the playing field with VZ.

When the playing field gets leveled, competition gets more fierce, and wireless coverage providers start engaging in a price war. The net result is negative for Verizon.

But that is all about to change. 5G is coming, and that means VZ once again has an opportunity to dramatically differentiate itself from the pack. Considering Verizon is still the 4G/LTE leader and that the company has significantly more resources than any of its competitors, it is quite likely that the company leads the 5G charge. If so, then VZ should have significantly better 5G coverage than competitors, meaning the playing field will once again be “un-level.”

When the playing field is “un-level”, Verizon regains its pricing power, and the company’s numbers improve.

The big risk here is the proposed merger between Sprint Corp (NYSE:S) and T-Mobile US Inc (NASDAQ:TMUS). But that combined entity is still smaller than VZ and should still be the second-place player in 5G. Plus, that risk seems to be compensated in the stock’s 4.8% dividend yield.

Dogs of the Dow 2: Exxon Mobil (XOM)

Dogs of the Dow 2: Exxon Mobil (XOM)

Source: Shutterstock

Oil giant Exxon Mobil Corporation (NYSE:XOM) has been one of the worst Dow stocks over the past several years as oil prices have slumped. Over the past year, XOM stock has fallen 6% versus the Dow’s 14% gain. Over the past three years, the discrepancy is worse. XOM stock is down 12%, while the Dow is up 34%.

But oil prices are rising. Steady production cuts from OPEC and others is a big reason why, as are global economic strength (which has firmed up demand) and rising geopolitical tensions (which has threatened global output).

All together, oil prices are hitting levels the market hasn’t seen in several years. That is a great thing for Exxon.

Historically speaking, XOM stock tends to track oil prices closely. As oil prices fall, so does Exxon stock. As oil prices rise, so does XOM.

Importantly, though, XOM stock’s volatility in these moves is relatively muted compared to oil price volatility. This is because Exxon is a giant business with tons of cash flows, big buyback power, a healthy dividend, and a long history of success. Those stable attributes help smooth out the volatility in oil prices.

From this perspective, XOM stock is a less volatile, less risky way to play a rise in oil prices.

Meanwhile, the valuation on XOM stock is attractive. The company is cheap by historical standards, with its trailing cash flow multiple currently hovering around 17 versus a 5-year average of 20. The dividend yield is also higher than normal at 4% (the 5-year average dividend yield is 3.2%).

Overall, XOM stock isn’t really priced for a comeback in oil prices. Thus, the risk-reward asymmetry on the stock skews towards the upside in the event that oil prices keep rising.

Dogs of the Dow: 3M (MMM)

3M MMM stock

Source: Dean Hochman via Flickr (Modified)

About two months ago, I warned that while industrial giant 3M Co (NYSE:MMM) was supported by a strong underlying growth story, the valuation on MMM stock looked out over its skis.

Since then, 3M stock has fallen nearly 20%. The company’s quarterly earnings came in shy of expectations, while the guide was also weak. Plus, broader market weakness has weighed on the stock.

But the plunge has brought 3M stock’s dividend yield to 2.5%. Not only is that the twelfth highest yield in the Dow, but it is also notably higher than the stock’s trailing five year average yield of 2.5%.

In other words, 3M stock is now being valued as if things are going to get a lot worse. But they won’t get a lot worse.

The quarter itself was pretty good, while the outlook for continued strength in the global economy remains positive. Every operating segment at 3M posted positive organic revenue growth in the quarter. Meanwhile, margins continued to trend higher. The outlook still calls for these trends to persist.

Overall, while everything isn’t perfect at 3M, everything isn’t awful, either. Considering the stock’s recent plunge amid still strong fundamentals, this looks like a good time to buy the dip.

As of this writing, Luke Lango was long VZ and MMM. 

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