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While many commentators were mesmerized by the Dow's eight-day winning streak -- which ended on Friday -- it's worth looking out a little bit further. Indeed, there are legitimate reasons to believe that the Dow will outperform the broader market over the medium to long term. One subset of Dow stocks looks even more promising.

The "high quality" theme is alive and well
The most recent forward-looking return estimates from fund manager GMO have "high-quality" U.S. stocks producing annualized real returns of 7.1% over the next seven years. (Given GMO's categorization of "high-quality" companies, we can consider that the Dow is a "high-quality" index.) That compares very favorably with GMO's meager expectations for large-cap and small-cap equities: just 1.5% and 0.1%, respectively. Part of the problem with these broader groups is valuation -- stocks just aren't cheap right now:


S&P 500

Cyclically adjusted P/E Multiple (based on 10-year average inflation-adjusted EPS)


Cyclically adjusted P/E Multiple -- Historical Average


3- to 5-Year Earnings-Per-Share Growth


Source: Robert Shiller and State Street Global Advisors.

6 Dow standouts
On the basis of the cyclically adjusted P/E multiple (calculated using average real earnings-per-share over the prior 10 years), there are six stocks in the Dow that sport a lower valuation and higher estimated earnings-per-share growth than the S&P 500:


P/E Multiple (10-Year Average Real EPS)

Long-Term Earnings-Per-Share Growth

Chevron (NYSE: CVX  )



Home Depot (NYSE: HD  )



American Express (NYSE: AXP  )



Caterpillar (NYSE: CAT  )



3M (NYSE: MMM  )



Intel (Nasdaq: INTC  )



Source: Author's calculations and Capital IQ, a division of Standard & Poor's.

Two of these stocks (Home Depot and 3M) even have lower volatility than the overall market, which looks like an unusually attractive proposition (if shares offer higher earnings growth and lower volatility risk than the market, one would expect to pay a higher, not a lower multiple).

A package deal or a short list
Bear in mind that this screen suggests these six stocks may outperform the SPDR S&P 500 ETF (NYSE: SPY  ) as a group -- it's a lot less useful in trying to draw conclusions on a stock-by-stock basis. For stock pickers, all is not lost, though: This group makes a pretty good short list of candidates for more detailed, company-specific research to determine whether any are legitimate values. Game on!

Between high valuations and slow growth, investors should expect disappointing returns from U.S. stocks as a whole over the next several years. Tim Hanson explains how to make more in 2010.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. American Express, Home Depot, and 3M are Motley Fool Inside Value picks. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.

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