Which 5 "Dogs Of The Dow" Are Worth Buying?

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The “dogs of the Dow” formula is a fine contrarian method of choosing stocks. Early in January of any year, find the Dow 30 Industrial Average members' worst performing stocks of the prior year, ignore the fact that most of these stocks, being “mega cap” stocks have lower betas than the market as a whole, and find a few reasons to invest in those laggards for the coming year. I am going to look at some of those Dow dogs today.

For comparison sake, in 2012, the S&P 500 returned 13.4% of capital gain, and including dividend yield, the total return was 16%. The Dow 30 Industrial average returned slightly less, with gains of 7.6%, plus average dividend returns to push the total return to about 10%. The worst performing company in the metric was Hewlett-Packard (NYSE: HPQ), which lost 44% of its value last year. The last several years have been dominated by failed acquisitions and declining markets in its core products of laser printers and personal computers. Hewlett Packard's answer to this? Focus on enterprise solutions, which will also require taking on the likes of Oracle (ORCL) and IBM (IBM), along with other well respected and entrenched competitors. Hewlett-Packard has made such a mess of its venerable name that I question whether it can be successful transitioning to its desired future.

Analysts have been slashing earnings estimates for Hewlett Packard. Ninety days ago, for fiscal 2013, which ends for Hewlett-Packard on October 31, 2013, the company was predicted to have earned $4.05 per share. The latest consensus is for fiscal 2013 earnings of $3.31 per share. I think it likely we will see further declines and don't expect 2013 earnings much above $3 per share. Ultimately, I expect Hewlett Packard to be split up and sold within the next few years, once fighting for profitability and growth appears to management to be pointless. Hewlett-Packard is too cheap to short, and too challenged to buy long. I would just avoid it.

Intel (NASDAQ: INTC) lost about 15% of its value in 2012. One commentator believes we would all be happiest if we considered Intel as we consider tobacco stocks. Big, high yielding, and stable. But what I see is a company whose bread and butter personal computer and laptop business is giving way to tablets and smart phones. Intel is not entirely ceding those growing personal technology niches, as its “Atom” series of processors is getting smaller, more efficient, and faster with each generation. Analysts believe that Intel is in for a period of declining earnings, a story I can agree with over the next eighteen months. But beyond, I see Intel, with its sterling balance sheet ramping up its research enough to get out of this funk. In the meantime, it well covered, 4.2% yield provides some cover. Patient investors can use this period of price weakness to get onboard this best in class tech company.

McDonald's (NYSE: MCD) had a rough 2012, losing about 12% of its value. McDonald's considerable success over the years was predicated on low costs, expanding geographic presence, and an ever emerging supply of teenagers. But dietary trends in the Americas and Europe have not been favorable to McDonald's, and limited product updates have not kept up with changing tastes effectively. McDonald's plans to launch another round of advertising for its flagship Big Mac to introduce it to its target teen audience. The company also plans to enhance its poultry offerings with its “Mighty Wings” line.

In 2011, McDonald's was the best performing Dow component. It is quite likely that the stock price that rose so sharply from 2009 through 2011 simply had gotten a little ahead of itself, and that 2012 was a natural corrective year. But earnings have not advanced in 2012. McDonald's has been battling rising commodity prices, and economic malaise among its customers, particularly in Europe where 40% of its restaurants are located. Revenues in 2012 are likely to be no more than 1% above 2011, and earnings should be essentially flat as well. More effective marketing will help some, but more than that is its markets, especially in Europe, must improve to allow more discretionary spending. When will recovery occur in Europe? I don't have a crystal ball, but McDonald's earnings are not going to tank, and while its markets improve, enjoy the 3.4% yield. I see this as a potential core holding for conservative investors.

DuPont (NYSE: DD) comes next, having lost about 2% of its stock value in 2012. This modest decline was ushered in by a horrendous third quarter, during which slackened demand for the company's chemicals led to sales in the quarter of $7.4 billion, 9% below the same quarter of 2011, and well below the $8.15 billion analysts had expected. Profits came in at $0.32 per share, versus the expected $0.48 per share. In response, the company announced 1500 layoffs.

Much of DuPont's business is tied into its titanium oxide pigments and line of coatings for solar panels. Price hikes on raw titanium oxide crushed margins in the pigment business, and solar slowdowns in Europe and China were behind most of the lightened revenue. But I expect both those markets to recover in 2013. I view the current weakness in DuPont as an excellent buying opportunity for this worldwide giant, which offers a fine yield of 3.8%

Finally, the last of the Dow 30 to fall in price in 2012 was Caterpillar (NYSE: CAT). I have been bullish on Caterpillar for years, and tend to view 2012 as just a blip in the company's long term growth. The company blames the flatness in 2012 on sluggish Chinese sales due to the slowdown of that market. Just over 25% of the company's sales are in China, and in response to that sluggishness the company has reduced its Chinese manufacturing capacity. It is not as if 2012 is going to be a total flop for the company either. I see earnings for 2012 arriving at about $9.00 per share, versus the $7.40 per share in 2011. But unless there is economic improvement in Europe and Asia, 2013 looks to be a real challenge. The company's high margined mining supply business it acquired in 2011 is also looking at leaner times next year.

With a current price to earnings ratio of just over nine, and what I believe is likely to be long-term growth ahead of it after 2013, I believe now is a great time to acquire Caterpillar as a long-term holding.

StockCroc1 has no position in any stocks mentioned. The Motley Fool recommends Intel and McDonald's. The Motley Fool owns shares of Intel and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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