By: Mario Ferro
August Marks Another Up Month
The year got off to an inauspicious start with weak performance for equities in January. But since then, and despite a less-than-ideal global economic and political backdrop, the bull market for equities (now in its sixth year) has regained its footing. As a result, key benchmarks such as the S&P 500 and Dow Jones Industrials have scaled new heights without suffering a correction. The Dogs of the Dow strategy has fully participated in the run up, with August marking a seventh straight month of advances in market value. (As a reminder, this trading system calls for buying equally weighted positions in the 10 highest-yielding Dow Industrials stocks at the beginning of the year, then repeating the process 12-months later.)
The Dogs, as a group, increased 1.6% in August. This compared to 3.4% for an equally-weighted position in all 30 Dow Industrials, and a 4.3% gain in the 20 components excluded from the Dogs. Performance was rather mixed among the group, with four of the 10 issues posting declines. By comparison, none of the other Dow Industrials backtracked last month.
Notable Movers
Merck (MRK) led the Dog pack for the month of August with a gain of 5.9%. The New Jersey-based drugmaker reported second-quarter earnings that were comfortably ahead of our expectations, thanks to better-than-expected performance on the top line and continued tight cost controls. Regarding the former, although worldwide revenues were down 1% year over year, to $10.9 billion, this was $300 million ahead of our estimate, as stronger gains in the company’s core franchises helped to mitigate generic competition and declines in Hepatitis-C drugs.
Microsoft (MSFT), took the number-two spot by rising 5.3%. The software giant’s June-quarter results appeared to please most investors, despite a $0.06 a share drag on the bottom line from the acquisition of Nokia Devices & Services. In the company’s Devices & Consumer segment, Office 365 remains quite popular. Microsoft is also making headway with Surface Pro 3, Xbox, and search engine Bing. Meanwhile, the Commercial division continued to perform very well, benefiting from the company’s strong market position in corporate data centers and the move to cloud and mobile computing.
On the other side of the ledger, AT&T (T) held the dubious distinction of posting the largest decline among the Dogs, shedding 1.8% of its market value for the month. The nation’s second-largest wireless carrier (behind Verizon, VZ) reported June-period results that were a bit on the light side. Indeed, share net of $0.62 for the interim missed our estimate by $0.08 and came in 7% below the year-earlier mark, as the transition to new, more-competitive mobile pricing plans weighed on profit margins. On the plus side, the new discount plans have reduced customer churn to record levels and have been a plus for wireless subscriber growth.
Year To Date, The Dogs Remain “Best In Show”
Through August, an equally-weighted position in the 10 Dogs of the Dow would have shown an increase of 7.7%. By comparison, doing the same with all 30 Dow Industrials would have resulted in a 5.0% gain in market value. Finally, holding the 20 components excluded from the Dogs would have left investors showing a 3.7% increase on their brokerage statements.
Although the Dow Jones Industrial Average has marched to ever higher records this year, it’s important to note that the current tide has not lifted all boats equally. In fact, just over one-third of its components were down in market value for the eight months through August. It’s also somewhat notable that the worst performer over this period, General Electric (GE, down 7.3%), is a member of the Dogs. If nothing else, this serves as a testament to the benefits of holding a diversified investment portfolio.
Intel Chips In The Most
Chip behemoth Intel (INTC) holds the top honor for cumulative performance, with a 34.5% advance for the year so far. This not only put it out in front of the Dogs, but also well ahead of all Dow members. The company announced very good news for the June quarter. Specifically, earnings per share came in at $0.55, which was well above our $0.44 estimate and the prior-year tally of $0.39. Intel benefited from its strategy to broaden the reach of its silicon content from data centers to PCs to the “Internet of Things”. With the rampup of its Baytrail SoC (system on a chip) family, it has expanded into new segments, including devices running Google’s (GOOG) Chrome operating system, and is on track to reach its goal of 40 million tablet computers sold.
Also giving the shares a boost was management’s announcement that the company intends to purchase $4 billion worth of common stock in the September interim, with more buybacks probable in the fourth quarter. Intel’s current stock-repurchase authorization is $20 billion.
Also putting in a good showing so far this year is Microsoft. With the help of its aforementioned gains in August, the price of its stock has risen 21.4% for the year to date. Overall, we like the direction the company has taken under CEO Satya Nadella, and holders of MSFT shares should continue to benefit.
Shares of Merck have also racked up solid gains this year, rising 20.1%. We believe Merck stockholders have reason to be optimistic about financial performance for the second half of 2014. Generic pressures are easing, particularly on SINGULAIR, and core franchises are performing well. While top-line pressures may linger for a few more quarters, we look for comparisons to get easier over the 2014-2015 time frame.
Pound Puppies
As mentioned earlier, General Electric, with its decline of 7.3% through August, has occupied the bottom rung for the better part of the year so far. The industrial conglomerate is in the midst of a transitional period, as it shifts toward a greater focus on infrastructure and technology. It has already divested its media unit (NBC Universal) and taken the first step in exiting the consumer finance business. More recently, GE agreed to sell its home appliance business to Sweden’s Electrolux for $3.3 billion in cash. Meanwhile, it plans to close on a $16.9 billion deal to acquire Alstom’s Power and Grid businesses by early next year, as it also enters into three joint ventures with the French train and turbine maker.
Elsewhere, Pfizer (PFE) was down 4.0% for the eight-month stretch. The drugmaker reported a 2% year-over-year decline in second-quarter revenues, continuing a downtrend that dates back to the fourth quarter of 2011. On a positive note, top-line results represented a significant improvement compared with the 9% pullback reported in the March period. We continue to view the company as a relatively safe choice in the pharmaceuticals space, owing to its strong financials, solid fundamentals, sizable share in most markets, and impressive track record of product development and pipeline replenishment.
Rounding out the laggards we have McDonald’s (MCD), whose shares were down 3.4% through August. Second-quarter financials did not live up to investors’ expectations, with revenues of $7.2 billion up less than 1.5% from a year earlier. The modest gain stemmed almost entirely from restaurant expansion and price increases, as global same-store sales were flat and guest traffic was negative in all of the company’s geographic segments. Moreover, the operating environment is not likely to change much through the rest of 2014. Global comps in the second half will likely be in line with the first two quarters. Still, the shares retain their appeal to conservative investors seeking current income. The issue’s yield is well above the Value Line median, and further increases (as well as stock repurchases) should be supported by the company’s ample free cash flow and solid Financial Strength (A++)
Conclusion
Overall, the equity markets’ resilience in the face of uneven domestic economic growth and political and military flare-ups overseas is notable. And the Dogs of the Dow, for their part, have put together a commendable aggregate performance so far this year. With little competition from alternative investments (most notably bonds), the low interest-rate environment should continue to support the case for equities, particularly these higher-yielding members of the Dow.
At the time of this article’s writing, the author did not hold positions in any of the companies mentioned.
