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Leigh Baldwin & Co.

112 Albany Street, Cazenovia, NY 13035 | Phone: (315) 655-2964 Toll Free: 1-800-659-8044

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Stock of the Week

Dogs of the Dow

December 26th 2014

Dogs of the Dow
12/26/14
Boeing (BA) $131.63
ExxonMobil (XOM) $93.21
GE (GE) $25.78
Chevron (CVX) $113.25
IBM (IBM) $162.34

Another great year for the major averages. The S&P 500 and the Nasdaq are up 15% year to date. With less than a week to go, the Dow Jones is up double digits rising over 18,000 following a great 2013 when the Dow rose over 30%. But even though the Dow has performed great once again, a number of Dow components are in the red for the year. As of Wednesday December 11, eight of the 30 Dow stocks were in the red for the year. One popular investment strategy that has good consistent success is buying the worst performing Dow components with the best dividend yields. The strategy operates on the theory that stocks who pay a high dividend will see higher total returns over the long run than stocks that don't. Since 2001, the strategy has outperformed both the Dow and the S&P 500 half the time and beat the Dow itself 12 of 14 times. Looking at the worst performing Dow components with negative returns for 2014, the list is impressive. IBM is currently the worst performing Dow component. IBM is three days away from a dubious stat, becoming the latest Dow component to finish dead last two years in a row. The last Dow component to do this was Bethlehem Steel. Bethlehem Steel was kicked out the Dow the following year. Besides IBM, the other worst performing Dow components include Chevron, GE, Exxon Mobil, and our recent featured stock, Boeing. Boeing is up 5% in the last week since we featured it, and while the rest of the dogs of the Dow may continue to underperform in the short term, I wouldn't be surprised to see IBM, Chevron, GE, and Exxon Mobil to outperform the Dow Jones Industrial Average by the end of next year. Besides the opportunity to outperform the Dow Jones, these dogs of the Dow also sport great dividend yields with an average of 3.26%. Investors looking for stocks with potential for above average returns with great quarterly income may want to take a look at these dogs of the Dow.

Globally, the Internet sector and cloud computing will continue to grow double digits which bodes well for tech firms like IBM. In the past 18 months IBM has quadrupled the number of cloud data facilities it offers around the world to 49. So while the cloud computing sector has performing well for IBM, the stock performance is certainly not what Ginny Rometty had in mind when she assumed the chief executive post on Jan. 1, 2012. Amid consistent revenue declines, IBM is down 12% since Rometty moved into the corner office. With the stock trading at a 3 year low and less than 10 times reduced earnings, it shouldn't take much good news to get IBM moving higher again. With Warren Buffett as a shareholder and a respectable dividend yield of 2.8%, I expect brighter days for IBM going forward.

Next up is the oil super major Chevron Corporation (CVX). Like Exxon Mobil, Chevron is down sharply from its summer highs. Chevron is dividend-raising powerhouse. Chevron has raised its dividend for 27 consecutive years and currently yields an attractive 4.1%. Chevron's dividend is about as safe as they come, with a payout ratio of just 38%. Over the past five- and 10-year periods, Chevron has raised its dividend at a 10.3% clip. To preserve their dividend and cash flow, Chevron this past week "indefinitely" suspended plans to drill for oil in Arctic waters, due to uncertainty over the outlook for crude prices. The move is the latest sign that a glut in crude oil is impacting major energy companies' exploration and production programs. The Arctic holds billions of barrels of untapped oil reserves, but offshore-drilling costs there are among the highest in the world due to its remote location and severe weather. Chevrons management has done a great job of keeping debt and costs down to improve their balance sheet. Chevron's debt-to-equity ratio is very low at 0.16 and is currently below that of the industry average. Chevron's earnings estimates have been severely hit with analysts slashing estimates by 34% for 2015. Currently, Chevron trades for 15.6 times reduced estimates, but a 4.1% dividend yield should limit the downside going forward. When oil does rebound, Chevron and their stock price will be one of the main beneficiaries.

By jettisoning so much of the consumer finance operation under Synchrony Bank, GE aims to become an industrial conglomerate rather than half-bank and half-conglomerate. The goal here is simple: to get a higher market multiple on earnings. GE is now valued at only 14 times expected 2015 earnings. The reality is this could translate to a much higher multiple if the market allows. United Tech trades at 15.5 times next year's earnings and 3M trades at 19 times next year's earnings. Could the post-reorg GE suddenly be worth 10% to 25% more based on a rotation of operations under a new valuation? That is the hope.

Exxon Mobil is a similar story to Chevron. Another great dividend stock with a yield of 3.1%, Exxon has boosted its' dividend every year for the last 32 years including the 1990s when oil dropped to $10 a barrel. The dividend payout is only 33% of its earnings so there is plenty of cushion to maintain and raise the dividend going forward. Exxon debt-to-equity ratio is very low at 0.12 and is currently below that of the industry average thanks to a strong management team. Earnings estimates and sales have been slashed for next year. Currently, Exxon is trading for 16 times 2015 reduced earnings. The dividend yield of 3.1% while not as impressive as Chevron should be good support for the stock. In the short term over the next several months, Exxon may see more downside, but long term is a great stock to buy and hold.

In 2014, Boeing shares have lost 4%, even though earnings per share are expected to be up 19%, to $8.38. Investors might fear that lower fuel prices will reduce the financial incentive for carriers to upgrade older planes. Not so far: Last quarter, Boeing's backlog of orders swelled to $490 billion from $440 billion. That represents more than five years' worth of revenue. Looking at 2016 estimates, for example, Boeing trades at 14.2 times earningsa good deal. But it trades at just 10.1 times estimated free cash. The shares could return 20%, including dividends.

A number of these Dow components rely on oil or International economies to keep earnings and sales growing so these five stocks are by no means diversified from each other. They may even correct further in the New Year. Most analysts and traders believe the price of oil will fall further before finally bottoming. But with a 25% correction from the mid-year highs, the energy sector is pricing in a lot of the bad news. According to Bespoke Investment Group, a sector's 20% or more divergence from the broad market is rare in history, and in past instances, that sector outperformed on average in the next 12 months. These dogs of the Dow may remain under pressure in the short term, but longer term these stocks are providing attractive valuations and great dividend yields for long term investors.