Updated on July 11th, 2019 by Bob Ciura
The “Dogs of the Dow” investing strategy is a very simple way for investors to achieve diversification and income in their portfolios while remaining in the sphere of more conservative blue chip stocks.
The strategy consists of investing in the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA) – an index of 30 large cap U.S. stocks.
We have compiled a list of the 30 Dow Jones Industrial Average stocks that you can access below:
This strategy produces above average income and concentrates on stocks that typically trade at lower valuations relative to the rest of the DJIA. Given that the DJIA represents some of the largest companies in the world, its “dogs” are typically companies with strong track records that have hit temporary problems.
For value investors looking to purchase good businesses that are currently out of favor, this is a great and simple strategy.
To implement this strategy, simply take the amount of money you have to invest and then divide it equally among the 10 highest yielding stocks in the DJIA. Hold these stocks for a whole year and then at the end of twelve months, look at the 30 Dow stocks again and resort them by dividend yield from highest to lowest.
Rebalance and reallocate your capital accordingly and repeat the process. In addition to the simplicity and focus on quality, value, and income that this strategy generates, it also improves discipline by preventing excessive emotion-driven trading.
It also encourages investors to reap the tax benefits from holding positions for at least one year before selling, thereby being taxed at the long-term capital gains tax rate instead of the short-term rate.
The 2019 Dogs of the Dow
The list of the 2019 Dogs of the Dow is below, along with the current dividend yield of the top-ten yielding DJIA stocks. Click on a company’s name to jump directly to analysis on that company.
10. Caterpillar Inc. (CAT): 3.1%
9. The Coca Cola Company (KO): 3.1%
8. Pfizer (PFE): 3.2%
7. Walgreens Boots Alliance (WBA): 3.3%
6. 3M Company (MMM): 3.3%
5. Chevron Corp. (CVX): 3.8%
4. Verizon (VZ): 4.2%
3. Exxon Mobil (XOM): 4.5%
2. IBM Corp (IBM): 4.5%
1. Dow, Inc. (DOW): 5.8%
Dog of the Dow #10: Caterpillar
Founded in 1925, Caterpillar is the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The $80 billion market cap company operates in three primary segments: Construction Industries, Resource Industries and Energy & Transportation, along with ancillary financing and related services through its Financial Products segment.
On April 24th, 2019 Caterpillar reported Q1 2019 results for the period ending March 31st, 2019. For the quarter the company reported revenue of $13.5 billion, representing a 5% increase compared to the prior year’s quarter. This growth in Caterpillar’s top line was driven by an 18% increase in Resource Industries, while Construction Industries and Energy & Transportation saw 3% and flat year-over-year growth, respectively.
Earnings-per-share came in at a record $3.25, representing a 19% increase compared to the $2.74 posted in Q1 2018; however, $0.31 of that improvement can from a discrete tax benefit. Caterpillar also updated its 2019 outlook. Expectations for the business are unchanged; however, as a result of the $0.31 tax benefit, the company revised its earnings-per-share outlook to a range of $12.06 to $13.06 (from $11.75 to $12.75 previously).
We expect 5% annual EPS growth for Caterpillar over the next five years. This could be a conservative estimate, particularly if the global economy avoids recession. Caterpillar continues to benefit from positive economic growth, and in particular its services business is a major future growth catalyst.
Source: Investor Presentation
Caterpillar expects to double its services revenue from 2016-2026. Assuming Caterpillar grows its EPS by 5% per year, the company should continue to raise its dividend each year, as it has for 25 consecutive years. Caterpillar is a recent addition to the list of Dividend Aristocrats, an exclusive group of 57 companies in the S&P 500 Index with 25+ consecutive years of dividend growth.
Caterpillar has an expected dividend payout ratio of just 29%, even after a recent 20% dividend increase. This propelled Caterpillar to join the list of Dogs of the Dow for this update. The forward annualized dividend of $4.12 per share results in a 3.1% dividend yield, making Caterpillar a highly attractive combination of dividend yield and growth.
Dog of the Dow #9: The Coca-Cola Company
The Coca-Cola Company is one of the largest beverages manufacturers in the world. It owns or licenses more than 500 unique non-alcoholic brands, in more than 200 countries worldwide. It currently has a market capitalization of more than $200 billion, and the company generates roughly $35 billion in annual revenue.
Source: Investor Presentation
Coca-Cola has long struggled against a backdrop of declining soda consumption in the United States. But its investments in new products are finally paying off, as the company has returned to organic growth.
Coca-Cola reported first quarter organic sales growth of 6% against a consensus for a 4% gain, led by strength in EMEA and in the bottling business. Two percent of the organic sales gain was from a timing benefit; excluding this gain, organic sales would have been in line with expectations. Unit case volume was up 4% as weakness in North America was more than offset by international strength.
Earnings-per-share from continuing operations grew 24% to $0.38, but comparable earnings-per-share rose just 2% to $0.48 despite an 11% currency headwind. Earnings-per-share included a $0.02 benefit from timing, primarily from the bottler inventory build related to Brexit.
The company continues to expect 4% organic growth and 12% to 13% in total sales growth. However, earnings-per-share is still expected to be flat to last year. Going forward, Coca-Cola’s biggest growth targets are coffee, natural drinks, and a renewed push into sports drinks.
Last year, Coca-Cola acquired Costa Coffee for $5.1 billion. Costa is a global coffee drink maker, and also operates a chain of nearly 4,000 coffee shops. Coca-Cola has also made smaller acquisitions to boost its portfolio of natural drinks like Kombucha. It also recently made a minority investment in the Kobe-Bryant backed sports drink manufacturer BodyArmor.
In addition to revamping its product portfolio, Coca-Cola made another strategic move to simplify its operations and increase its profitability. Coca-Cola has sold its bottling businesses in the U.S., Europe, China, and Africa. This helps Coca-Cola’s bottom line because bottling is a capital-intensive business, with low profit margins.
Coca-Cola currently pays a dividend of $1.60 per share, equaling a 3.1% current yield. Coca-Cola has increased its dividend for over 50 years in a row, making it a member of the exclusive Dividend Kings.
Dog of the Dow #8: Pfizer
Pfizer was founded in 1849 and has grown into one of the largest pharmaceutical companies in the world today. It researches and manufactures drugs for a variety of therapeutic areas and has two core operating segments: Innovative Health (62% of 2018 revenue) and Essential Health (38% of 2018 revenue).
The most common therapeutic areas for Pfizer are internal medicine, oncology, immunology, inflammation, and rare diseases. Pfizer’s global portfolio is based mostly on biopharmaceuticals, but it also includes vaccines.
Source: Investor Presentation
Pfizer’s revenue grew by 2% during 2018 while adjusted earnings-per-share grew 13% as its larger Innovative Health business grew revenue by 6%, while its smaller Essential Health business saw sales decline by 5%.
Innovative Health benefited from the company’s years of significant investments in its R&D pipeline as its flagship products Eliquis (up 31%), Xeljanz (up 37%), and Prevnar (up 13%) drove sales growth.
Going forward, Pfizer sees the potential for approximately 25-30 significant product approvals through 2022, of which up to 15 have the potential to be blockbusters and expects seven of the 15 to receive approval by 2020.
In particular, Pfizer has a very strong oncology development pipeline with 13 oncology products in Phase I of development, another 4 in Phase II, and 6 in Phase III.
In the short run, however, adjusted earnings per share are expected to decline by approximately 4% as the company focuses its cash on its pipeline investments and performance continues to weaken in the Essential Health segment as patent expirations and pricing weakness negatively impact its legacy established products in developed markets.
Given these two conflicting dynamics, we expect earnings-per-share and dividends to grow at an average of 5% per year over the next half decade.
With manageable debt level, strong interest coverage, and a payout ratio of 50%, Pfizer should be able to easily continue raising its dividend each year moving forward. Pfizer also has a strong moat from its robust product pipeline and patent portfolio, securing its earnings power and driving future growth.
Dog of the Dow #7: Walgreens Boots Alliance
Walgreens Boots Alliance is the largest retail pharmacy in both the United States and Europe. Through its flagship Walgreens business and other business ventures, Walgreens has a presence in more than 25 countries and employs more than 415,000 people.
In its leading retail pharmacy business Walgreens operates approximately 18,500 stores in 11 countries, and also operates one of the largest global pharmaceutical wholesale and distribution networks, with more than 390 centers that deliver to upwards of 230,000 pharmacies, doctors, health centers and hospitals each year.
In its recent FY19 Q3 results, Walgreens reported net sales growth of 0.7% (2.9% on a constant currency basis) to $34.6 billion compared to the same quarter last year, due to 2.3% growth in the Retail Pharmacy USA division. Adjusted net earnings decreased 12.1% to $1.3 billion and adjusted earnings-per-share fell 4.0% to $1.47, as the decline in net earnings was partially offset by a substantially lower share count.
Walgreens also reiterated its fiscal year 2019 outlook, indicating that adjusted earnings-per-share are anticipated to be roughly flat year-over-year. This is consistent with what the company said last quarter, but down from previous guidance of 7% to 12% to start the year.
Over the long-term the company still believes it can grow the bottom line in the mid-to-high single digits. However, investors should be somewhat skeptical of this forecast, given the sharp declines in growth and increasing competition in the space.
Therefore, we anticipate earnings per share growth in the mid-single-digits over the next half decade supported primarily by share repurchases and an aging population.
Source: Earnings Presentation
Despite these challenges, Walgreens still enjoys a significant competitive advantage thanks to its vast scale and network in an important and growing industry.
Meanwhile, the payout ratio remains reasonable and supports continued dividend growth. Walgreens is also fairly recession resistant, with its earnings per share dipping only 6.9% in 2009.
The company also holds a very strong balance sheet with $818 million in cash, $19.9 billion in current assets (including $10.2 billion in inventory) and $70.4 billion in total assets against just $25.3 billion in current liabilities and $45.0 billion in total liabilities.
The following video analyzes Walgreens’ dividend safety in further detail:
Walgreens has increased its dividend for 44 consecutive years, including a 4.5% increase on July 10th. This makes Walgreens a member of the Dividend Aristocrats. The new quarterly dividend payout of $0.4575 per share represents an annual payout of $1.83 per share, good for a 3.3% forward yield.
Dog of the Dow #6: 3M Company
3M is an industrial manufacturing giant. It has a long track record of growth, and like Coca-Cola is on the list of Dividend Kings for having raised its dividend for at least 50 consecutive years.
Business conditions suddenly deteriorated to start 2019. 3M released weak first-quarter results and significantly reduced its full-year outlook. Revenue declined 5% to $7.9 billion, which was $162 million below expectations.
3M’s first-quarter EPS was reduced by $0.72 due to litigation-related charges. The company is involved in a number of legal proceedings, which represent a significant headline risk. 3M incurred a total litigation-related pre-tax charge of $548 million in the first quarter.
3M’s elevated litigation expense is a dark cloud over the stock right now. While it is likely 3M is strong enough to withstand the litigation risk, investors should pay close attention to the company’s future results to make sure the situation does not worsen.
3M also lowered its earnings-per-share guidance to $9.25 to $9.75 for 2019, down from $10.45 to $10.90 previously. At the midpoint of guidance, EPS is likely to decline ~9% in 2019, compared with last year. Organic revenue growth is now expected in a range of down 1% to up 2%, a big drop from previous guidance of 1% to 4% growth.
Despite the company’s challenging first-quarter and lowered full-year forecast, the long-term outlook is still positive. 3M has long-term growth catalysts, primarily its healthcare segment.
The demographics of the U.S. health care industry are highly supportive of growth, due to the aging population. 3M is already a major healthcare product manufacturer, with segment sales above $7 billion each year. Healthcare is expected to lead 3M’s growth in the years ahead, particularly with the recent $6.7 billion acquisition of Acelity.
Source: Investor Presentation
Acelity manufactures wound dressings and other specialty surgical products. It will expand 3M’s Medical Solutions business with a high-growth category. Acelity generated $1.5 billion of sales last year, growing at a 10% rate in 2018 with attractive margins.
Excluding certain one-time transaction and integration expenses, 3M expects the deal to be accretive to earnings by $0.25 per share in the first 12 months after closing. 3M paid approximately 11x estimated annual adjusted EBITDA for Acelity, which is a reasonable multiple for a fast-growing, high-margin business.
3M has a long dividend history. It has paid uninterrupted dividends to shareholders for over 100 years. It has also raised its dividend for the past 61 consecutive years, including a 6% increase in February 2019.
We continue to view 3M’s dividend as secure. We discuss 3M’s dividend safety in further detail in the video below:
3M’s dividend growth should continue for the foreseeable future. Even though EPS will be lower this year than the company previously anticipated, 3M remains highly profitable.
At the midpoint of revised guidance, 3M’s dividend payout ratio of 61% still represents sufficient coverage, with room for future dividend hikes provided the company’s turnaround is successful.
Dog of the Dow #5: Chevron
Chevron is the third-largest oil major in the world, behind only Shell and ExxonMobil. The company’s main competitive advantages are its size and industry position, giving it economies of scale, operational expertise, and a vast business network through which to access lucrative deals.
In 2018, Chevron grew earnings-per-share by 60% with the upstream segment serving as the biggest contributor with 63% earnings growth in that business during the year. As a result, Chevron hiked its dividend by 6%.
In late April, Chevron reported (4/26/19) financial results for the first quarter of fiscal 2019. Its production grew 7% over last year’s quarter, primarily thanks to strong performance in the Permian Basin and at Wheatstone in Australia.
Total output exceeded 3.0 million barrels per day for the second quarter in a row. However, earnings fell 27%, from $3.6 to $2.6 billion. Half of the decrease resulted from low margins in the refining and chemical business while lower oil prices also played a role.
The biggest driver of this robust growth despite volatile prices was increased production. Chevron has extensively invested in growth projects for years but has failed to grow its output for an entire decade, as oil projects take several years to start bearing fruit.
However, Chevron is now in the positive phase of its investing cycle, as its investments are now online and increasing output even as capital expenditures decline. The company expects to grow its output by 4%-7% this year and by 2%-3% per year for the next five years.
Chevron’s growth will be fueled by rising demand for its products around the world.
Source: Investor Presentation
Given the magnified effect of production growth and the corresponding impact to Chevron’s earnings-per-share, we believe the company is likely to achieve total earnings-per-share growth in the 5%-6% range annually.
Chevron has above-average dividend safety, considering its industry. As a commodity producer, the company is vulnerable to any downturn in the price of oil. Fortunately, thanks to rising production and declining CapEx, Chevron’s dividend is safer than it has been in a while as its payout ratio has fallen to a more reasonable level of 58%.
Even though Chevron operates in a cyclical industry, we believe the dividend is secure. The following video provides further explanation:
As a result, we believe they will continue raising their dividend for the foreseeable future, especially considering that it is already a Dividend Aristocrat with 32 consecutive years of dividend growth.
Dog of the Dow #4: Verizon
Verizon operates in the telecommunications sector as one of the largest wireless carrier in the country. Wireless contributes three-quarters of all revenues, and broadband and cable services account for about a quarter of sales. The company’s network covers ~298 million people. Verizon has a market capitalization of $236 billion, with annual sales of $131 billion.
Verizon reported financial results for the first quarter on 4/23/2019. The company earned $1.20 per share, topping estimates by $0.04 and growing 2.6% from the previous year. Revenue grew 1.1% year-over-year to $32.1 billion, which was in-line with what analysts were expecting. Revenues for wireless grew almost 4% to $22.7 billion. Higher priced plans helped grow service revenues by 4.4%.
Verizon’s wireline business experienced a revenue decline of 3.9% to $7.3 billion, while Fios sales improved 3.6% to $3.1 billion. The company added 52K net Fios connections, but lost a net of 53K Fios video subscribers.
Based on first quarter results, Verizon now expects earnings-per-share to increase at a low-single-digit rate from 2018 versus previous guidance of no growth. Revenues for the year are still expected to grow at a low single-digit rate.
Looking ahead, however, growth is expected to slow with EPS forecasted to be flat in 2019 and revenue growing in the low single digits due to margin pressures from increased competition. As a result, we only expect 4% annual EPS growth over the next half decade.
Source: Investor Presentation
The company has now increased its dividend for the past 14 years and should continue doing so for the foreseeable future.
The following video analyzes Verizon’s dividend safety in the context of its fourth-quarter earnings report:
Verizon’s economic moat resulting from its large scale, network advantage, and brand power in the U.S. should enable it to continue growing with healthy margins, despite growing competition.
This is evident by the company’s wireless net additions and very low churn rate. Management is also taking steps to deleverage Verizon’s balance sheet which should also increase its safety. Verizon’s high dividend yield above 4% is attractive to income investors.
Dog of the Dow #3: Exxon Mobil
Exxon Mobil is an energy giant with $290 billion in annual revenue and net profits in excess of $21 billion. In 2018, the company generated 60% of its earnings from its upstream segment, 26% from its downstream (mostly refining) segment and the remaining 14% from its chemicals segment as it grew revenues by a robust 18.8% increase year-over-year, led by a near doubling in upstream earnings.
While it is a diversified business, Exxon’s results are highly cyclical due to its exposure to the economy and commodity prices. However, given its diversified nature, Exxon is still able to remain profitable through economic and commodity cycles, enabling it to grow its dividend for 36 straight years.
In late April, Exxon reported (4/26/19) financial results for the first quarter of fiscal 2019. The company posted production of 4.0 million barrels per day, up 2% over last year’s quarter. However, its earnings-per-share plunged 49%, from $1.09 to $0.55, and missed the analysts’ consensus of $0.68 by 19%.
Half of the earnings decrease resulted from poor margins in refining and chemicals, as well as heavy scheduled maintenance. Refining margins were affected by the collapse of the discount of Canadian crude to WTI due to Alberta’s enforced production cuts and additional takeaway capacity in Permian.
The upstream business tends to thrive when oil prices are high and the downstream and chemical businesses continue to churn out cash flows when oil prices are suppressed.
Source: Earnings Presentation
Looking forward, we anticipate the company’s admirable dividend growth streak to continue on the back of management’s forecast for 140% earnings growth by 2025 thanks to the boom in Permian and Guyana production to meet growth in global energy demand as the developing world continues to increase energy consumption.
To fuel this growth, Exxon is planning to ramp up its capital spending in order to capitalize on its attractive cost of capital and high return on investment opportunities (20% expected returns on capital forecasted in new investments in the upstream business).
Furthermore, if/when oil cycles down again, the company’s flexible balance sheet and the fact that its dividend and spending requirements are fully covered at $40/barrel should enable the company to continue paying and growing its dividend well into the future.
Like Chevron, we believe Exxon Mobil has a secure dividend. You can view the below video for further discussion of Exxon’s dividend safety:
Dog of the Dow #2: IBM
IBM is an information technology company which provides integrated solutions that leverage information technology and knowledge of business processes. The company was founded in 1911, and currently operates five business segments: Cognitive Solutions, Global Business Services, Technology Services & Cloud Platforms, Systems, and Global Financing.
IBM generates annual revenue above $79 billion. IBM is currently transitioning away from its legacy businesses towards its self-described “strategic imperatives” in data, mobile, security, and analytics After several years of stagnant and/or declining revenues as the company changed strategies, IBM has finally recently returned to revenue growth.
IBM reported 2019 first-quarter results on April 16, 2019. Earnings per share of $2.25 beat estimates by $0.01 but revenue of $18.1 billion was down ~1% in constant currency and missed estimates. Cloud & Cognitive Software grew revenue 2% while Global Business Services grew revenue 4% on a year-over-year basis.
On the other hand, Global Technology Services saw revenues decline 3% and Systems revenue decline 9%. Notably, the cloud and software-as-a-service (SaaS) categories are increasing revenue at 12% to $4.5 billion and 15% to $11.7 billion, respectively. Due to IBM’s global operations, foreign currency exchange headwinds had a meaningful impact causing a 4% decline in revenue. IBM is forecasting a 2% revenue decline for the full fiscal year, due to currency exchange.
IBM’s future growth will be boosted by its $34 billion acquisition of Red Hat, an open-source cloud solutions provider. Red Hat has a leading position in hybrid cloud, which would in turn make IBM the No. 1 provider of hybrid cloud solutions. Hybrid cloud is a mixed computing environment that uses private cloud and third party cloud. The deal is expected to be accretive to cash flow and accelerate revenue growth.
Red Hat operates in the open-source software market and primarily distributes technology products used in data centers. In addition, the company’s own growth segments, collectively referred to as the strategic imperatives, are growing at a high rate.
Source: Investor Presentation
Despite IBM’s prolonged difficulties, the company still has a strong balance sheet and a sustainable dividend with a dividend payout ratio below 50%. It has also shown remarkable commitment to growing its dividend as it is about to become a Dividend Aristocrat.
IBM has a price-to-earnings ratio of just 10.0, meaningfully below our fair value estimate of 12.0. This means the stock is significantly undervalued.
With a low stock valuation, a high dividend yield, and over 100 years of dividend payments, we consider IBM a “blue-chip stock”.
You can see a list of four other blue-chip dividend stocks in addition to IBM, in the video below:
Dog of the Dow #1: Dow, Inc. (DOW)
The highest-yielding Dow Jones Industrial Average component is Dow, Inc., a newly-formed stock after the recent separation of its former parent, DowDuPont. That company has broken into three publicly-traded, standalone parts, with the former Materials Science business becoming the new Dow Inc.
Source: Investor Presentation
Dow will produce about $46 billion in revenue this year and the stock trades with a market capitalization of $35 billion. The company released its own first quarter earnings report on 5/2/19 in anticipation of the spinoff.
Total revenue fell 10% year-over-year, in line with prior guidance, to $10.8 billion. Volume grew 1% overall as Industrial Intermediates & Infrastructure gained 6%, while Performance Materials & Coatings rose 1%. That was partially offset by a 2% decline from Packaging & Specialty Plastics.
Pricing took a significant toll on the company’s top line, however, as it declined 9% year-over-year. All segments saw pricing declines with the exception of Performance Materials & Coatings, which managed to come in flat in the first quarter. The decline in pricing was primarily due to the company’s polyethylene, isocyanates, and hydrocarbon products.
Dow is on a path to achieve significant cost savings this year, as it achieved $125 million in savings in Q1 alone. Dow exited Q1 with a $1.365 billion annual cost synergy run-rate.
The company announced a $3 billion share repurchase program, good for ~9% of the float, and a quarterly dividend of $0.70 per share. Management stated it is committed to offering an industry-leading dividend to shareholders.
Dow’s payout ratio is currently at around two-thirds of earnings, which is where we expect it to stay. The company’s growth outlook is reasonably strong, meaning there shouldn’t be any dividend safety issues, even if a recession strikes.
Given the descriptions above, the Dogs of the Dow are clearly a very diverse group of blue chip companies which each enjoy significant competitive advantages and lengthy histories of paying rising dividends.
As a result, this investing strategy is a great, low-risk way for unsophisticated investors to approach dividend growth investing.
While it may not outperform the broader market every year, it is virtually guaranteed to provide investors with a combination of attractive current yield with steadily rising income over time.