Overview: Dogs of the Dow
With it being a slow news period over the next couple of weeks and with 2018 just around the corner, we thought it would be a good time to explore the Dogs of the Dow strategy. In simple terms, the Dogs of the Dow strategy is to consider investing in the poorest-performing Dow components in the prior year with the hope they will make a nice rebound in the following year.
The strategy worked pretty well in 2017. The worst performers in 2016 were Nike (NKE) and Coca-Cola (KO), which were the only two stocks in the red. Other weak components that managed only small gains were Disney (DIS), Visa (V) and Home Depot (HD).
Their performance thus far in 2017 is as follows: V +45%, HD +41%, NKE +24%, KO +10%, DIS +5%. That's pretty good overall. The DJIA is up 25% on the year, so two of the five performed much better than average while one was in-line. Visa and Home Depot really posted big moves in 2017. In fact, Visa wound up being a Top 4 Dow Performer in 2017 and HD was not far behind. Even the two on the lower end (KO, DIS) posted decent but not great gains. But at least they are in positive territory. Overall, these five stocks seem to have held their own pretty well.
2018 Rebound Candidates: Let's turn to 2017 to reveal the dogs this year. First of all, we are excluding DowDuPont (DWDP), which was created via the merger of Dow Chemical and DuPont. The merger was completed on September 1, 2017, so it was not around on January 1 so let's put that name aside.
Of the remaining Dow components, by far the biggest loser in 2017 has been GE -44% and it's not even close. The next few worst performers have been: IBM -8%, XOM -7%, MRK -4% and VZ +0%. Over the next week or two, we will publish a few story stocks that look at some of these names individually. On a final note, in case you're curious, the biggest Dow winner by far this year has been BA +90%. Other big movers include: CAT +69%, AAPL +47%, V +45%, WMT +43%, HD +41%, MCD +40%.
Dogs of the Dow Spotlight: IBM (IBM)
Today we wanted to shine the spotlight on IBM. While IBM being down -8% for the year does not sound horrible, keep in mind that the Dow Jones overall is +25%, so it has significantly underperformed the overall market. It's now trading around $153 after starting the year in the $165 range. It has been the second worst Dow performer in 2017, better than only GE. The stock has been trending lower in recent years, going from $210 in early 2013 to as low as the $120 range in early 2016. The stock had a nice move in 2016, but has struggled again in 2017.
So why has the stock been so disappointing even as other technology names have soared in recent years? A big part of it is that IBM has historically been a hardware-based, large mainframe type business. But the world is changing. Enterprise customers have been moving to the cloud and network virtualization. Also, competition as gotten more intense over the years as younger upstarts have been built from the ground up on cloud, mobility, virtualization etc. Amazon (AMZN) has been very successful with its public cloud computing offering. IBM has had trouble adapting to this new world and its profits have been declining for years.
IBM has taken steps to evolve by focusing more on software, services, systems and they have been marketing themselves as a provider of integrated solutions. Their key areas of focus are cloud, analytics, mobile, cybersecurity, social media etc. The company has been making progress.
In its most recent earnings report, IBM reported that total revenue for the nine months ended Sep 30 had declined 2.7% YoY to $56.6 bln. However, Q3 cloud revenue increased 20% YoY $4.1 bln. Cloud revenue over the last 12 months was $15.8 bln, including $8.8 bln delivered as-a-service and $7.0 bln for hardware, software and services. The annual exit run rate for as-a-service revenue increased to $9.4 bln from $7.5 bln in 3Q16. Revenue from analytics increased 5% in Q3 and mobile increased 7%.
In sum, IBM is a massive company and it cannot turn itself on a dime, but they are taking steps to compete better in today's cloud computing environment. The stock trades at a P/E of just 11x based on 2018 EPS estimates so its valuation is pretty attractive. It also pays a 3.9% annual dividend yield which is quite good. Also, management has been aggressive in terms of buying back stock. It recently increased its share buyback authorization by $3 bln. This amount is in addition to $1.5 bln remaining from a prior authorization.
Looking ahead, IBM's Q4 earnings report around January 18 will be an important event. Not so much for the Q4 results, but IBM is expected to provide 2018 guidance for the first time. That'll be an important test and a good window into management's view as to how the turnaround will progress in 2018.