We are at that time when looking back at the year that was will become a very popular thing to do for fund managers and the like who will measure their performance against stock indices and averages. The problem this year is that averages are misleading. As the year has gone on, the spread of performance between sectors and styles of stocks has grown to the point where the average of them tells us just about nothing.
The best performing SPDR Sector ETF by far is energy (XLE), which has returned 54% so far this year, as compared to the worst performing, consumer discretionary (XLY), which has lost 33%. That massive spread is why looking at the performance of any average is limited in its usefulness. Even within those sector averages, there are distortions, too. The big losses in XLY are driven mainly by its two biggest components, Amazon (AMZN) and Tesla (TSLA) which, combined, make up nearly 37% of the fund and which have dropped 49% and 54%, respectively. That drags the sector down, more than negating some small positive years from stocks like McDonald’s (MCD).
With the exception of energy stocks, what sector or industry a company operates in has not been a major factor in how their stocks have performed. What has mattered is how high their P/E, or earnings multiple, was coming into the year. Sky-high P/Es, based on assumptions of strong growth, are really no more, certainly when it comes to established businesses.
All of this matters to investors because it makes one of the more popular year-end strategies questionable at best. Many investors look at underperformers from the year and invest in these on the basis that, in markets, everything eventually returns to the mean. That strategy will not be as effective as it has been in the past. If a stock has fallen to below an average multiple because an industry is out of favor it will probably bounce back, but if it has dropped from an earnings multiple of, say, ten times the average to five times, it may never regain that 10x level. That isn’t to say that stocks like AMZN and TSLA can’t bounce back next year -- they certainly can, but it will probably be based on earnings growth that outstrips now-reduced expectations rather than an expansion of the adjusted multiples.
So, what investors should be looking for as this year ends are not necessarily the worst performers of the year, but underperformers with P/Es that are already below average. Or, to put it another way, good old-fashioned value.
That brings in an old strategy known as the “Dogs of the Dow”, which identifies the best value in the group of stocks that make up the Dow Jones Industrial Average based on those that have the highest dividend yield. It may seem strange to look for opportunity based on yield at a time when the Fed is raising interest rates, thereby reducing the value of a stock’s yield, but the whole point of the strategy is that it ignores what is happening now and assumes that things will change before too long. It is, in many ways, the ultimate contrarian strategy. Like any strategy, though, it is best applied selectively.
According to the website Dogsofthedow.com, the top ten dogs right now are as follows:
And there are a few there that stand out to me, both as possibilities and as stocks that may be value traps.
Starting with the negative, Verizon (VZ) may have the highest yield in the Dow, but in current circumstances it may not represent the best value. One could argue that the telecoms industry is one that will do well whatever economic conditions next year brings, but their problems are not really based on their industry, but more about their competitiveness within it. That can be seen by the fact that VZ is down 23% YTD, whereas its competitor, AT&T (T) has gained over 6% this year. The problem is that VZ lost their network superiority, and that will take a long time to fix, so a recovery next year looks unlikely.
On the positive side, there are a couple of stocks on this list that do offer serious upside. Two of the “old tech” names there, Intel (INTC) and Cisco (CSCO), have been dragged down by pessimism around tech, but that has been about adjusting inflated P/Es more than anything, and they don’t fit that description. If anything, at 8.4 and 17.2, respectively, their P/Es look low in an environment where companies are expecting to expand IT spending, whatever the state of the economy.
Others that appeal to me include Walgreens Boots Alliance (WBA), with a P/E of 7.8 and Chevron (CVX) which, despite huge gains this year still appears on the list and has a P/E of 9.6.
Overall, the lesson when looking back at the year is that investors should be careful about using simplistic analysis. The variation in performance, both between and within sectors, has been so great that lumping things together will give a false impression. However, digging a little deeper and looking at stocks individually will reveal that there is some value to be found.
* In addition to contributing here, Martin Tillier works as Head of Research at the crypto platform SmartFI.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
Read Martin's Bio