The contrarian “Dogs of the Dow” approach traditionally selects holdings from among the 30 companies in the Dow Jones Industrial Average (DJIA). (See “Time Again To Look For Mid-Year 'Dogs Of The Dow'.”) While doing so can produce an acceptably diversified portfolio, that approach omits two key, contrarian sectors in today's market: transportation and utilities.
Disclosure: Author holds
Why bother? Because those two sectors have been significantly underperforming the general stock market. Therefore, the DJTA and DJUA should contain some attractive (contrarian) stocks to add to the portfolio.
The solution is straightforward: select similarly attractive stocks from the 20-company Dow Jones Transportation Average (DJTA) and the 15-company Dow Jones Utility Average (DJUA). The decisions to make are how many and which companies.
Stock chart courtesy of StockCharts.com
Note: A natural question is why not use the Dow Jones 65 Composite Average, composed of the DJIA, DJTA and DJUA companies. The answer is its imbalanced sector allocation, as is shown at the end of this article.
Selecting transports from the DJTA
As with the DJIA, we could rank the 20 stocks by year-to-date (YTD) performance. However, there are three considerations to make:
- Industry – Transportation services has three major industry groups to choose from: Air Delivery & Freight Services, Airlines and Railroads
- Size – Unlike the DJIA, some of the transportation companies are smaller
- Dividends – Also unlike the DJIA, some transports have no dividends
In using a “dog” approach, it is important to diversify among industries. Also, larger size is as an indicator of resources and diversity. Additionally, selecting dividend-paying stocks offers some price support.
Here, then, is how the twenty DJTA transportation stocks sort out:
In selecting from among the companies, the noteworthy points are:
- Of the three major industries, airlines and railroads are the lower performing, and, therefore, better looking “dogs”
- In airlines,
United Continental Holdings has the lowest YTD performance, but pays no dividend, leaving Southwest Airlines as the lowest performing choice - In railroads, the missing major is Berkshire Hathaway’s BNSF. Of the four in the DJTA, Union Pacific is the clear leader in size and resources
Thus, the combination of the DJTA’s leading, contrarian companies – Southwest Airlines and Union Pacific – offers good diversification and return potential to the five-stock DJIA Dogs of the Dow portfolio.
Selecting utilities from the DJUA
Following the same logic of examining industry as well as performance, the choice is easy, with one proviso: the need to select from regional companies. Because utilities operate regionally, a “leading” company is one that is a sizeable representative of the industry. Here, then, is the ranking:
So, how many? Like with the transports, my preference is for two leaders from the three largest industries: diversified, electric and natural gas utilities. With the diversified having better performance, that leaves electric and gas. Among the electrics, note the bunching of the lower performers, underscoring the industry’s common characteristics. Among the four largest companies, Southern Company and Duke Energy are similar, although the former has a slightly lower performance and a higher yield.
The natural gas utility industry has only one representative in the DJUA: CenterPoint Energy (the S&P 500 includes four, with CenterPoint being the largest). Much of the industry's natural gas distribution is done through the diversified utility companies. (In fact, CenterPoint also distributes electricity throughout the Houston area.) The benefit of holding a natural gas-focused company is to get a more pure play from the possibilities afforded by a cheap, clean-burning fuel. This focus can be seen in CenterPoint's "Vision & Strategy" discussion that includes the following:
To build a domestic energy company with a balanced portfolio of electric and natural gas businesses, we seek to:
- Pursue geographic, economic and regulatory diversity
- Capture robust organic growth in our electric and natural gas footprint and seek opportunities to acquire other regulated electric and natural gas businesses
- Take advantage of our strategically located interstate pipeline assets and their access to active natural gas supply basins and attractive end use markets
- Invest in gas gathering and processing assets in attractive gas producing areas
- Expand our competitive natural gas sales and services to select commercial, industrial and utility customers
- Remain committed to our original investment thesis of producing predictable and growing earnings and cash flow with a competitive dividend
Putting it all together
The table below shows the completed portfolio composed of the five DJIA stocks picked previously along with the two DJTA stocks and two DJUA stocks selected above. Comparing the dividend yield and, in particular, the performance results to the stock market overall shows clearly the contrarian nature of the 9-stock portfolio.
The bottom line
The stock market’s current position provides a good opportunity to build an attractive contrarian portfolio. In the current market environment, no contrarian portfolio is complete without some beaten-down transportation and utility stocks.
Stock chart courtesy of StockCharts.com
Why not use the Dow Jones 65 Composite Average (DJ65)?
This rarely used index combines the DJIA, DJTA and DJIA together (30 + 20 + 15 = 65). Using that combo to pick bottom performers might seem a reasonable approach. However, the much large concentration in transports and utilities would mean a poorly diversified portfolio.
For that reason, too, the DJ65 is a poor index. Like the DJIA, DJTA and DJUA, the stocks are weighted by stock price, not market capitalization. While Dow Jones has been careful with sector/industry weightings for each of the three, separately, the DJ65 is not constructed, so throwing the three together produces a poorly constructed market index. The table below shows the DJ65’s huge overweighting of the transportation and utility sectors (44%), compared to the weighting in the S&P 500 (5%).
