Dow Stocks for Growth: "Are You Kidding Me?"

Don't let it get away!

Keep track of the stocks that matter to you.

Help yourself with the Fool's FREE and easy new watchlist service today.

Stocks in the Dow Jones Industrial Average (INDEX: ^DJI  ) are a fairly safe way to invest for the long term. Most of these companies have been around a very long time and have solid track records of growth, value, or both. Previously I've written that investors would rather receive higher dividends from Dow stocks instead of capital appreciation. I have also written about "Dogs of the Dow" stocks and a strategy for achieving very good returns using a dividend reinvestment strategy.

Both discussions, however, sidestep the issue of treating Dow stocks as growth investments. Common knowledge is that growth stocks will have higher price-to-earnings ratios because their earnings are expected to grow more quickly over time. To find a suitable growth stock, the P/E should be less than the sum of the earnings growth rate and dividend yield (or just the earnings growth rate if the company does not pay a dividend). If the P/E is lower than the sum of these two metrics, then there is room for the stock price to advance higher, or vice versa if the P/E is higher than earnings growth and dividend yield.

For this commentary, I'll focus on the three highest P/E Dow stocks: AT&T (NYSE: T  ) ; Verizon Communications (NYSE: VZ  ) , and Alcoa (NYSE: AA  ) .



Payout Ratio



Forward EPS (est. 2013)

Earnings Quality Since January







A => C







A => B







A => C

Before I continue, a word about earnings quality. All three of these stocks have experienced declines in earnings quality since January for one reason or another, as evidenced by their TMF Earnings Quality Score. Earnings quality is partly a function of price, and as price rises, the EQ score can suffer.

AT&T has two strikes against it right off the bat, because it has the highest dividend yield and P/E ratio of any stock in the Dow. It also has a payout ratio of 254% of earnings, which means it's using operating cash (or borrowed funds) to make the dividend payouts. However, the trailing-12-month $0.69 EPS does not tell the whole story because the company experienced a loss of $1.13 for the quarter ending Dec. 31, 2011. Nonetheless, the growth in EPS ($0.60 to $2.56) equals 271% -- well beyond the P/E ratios, current or forward looking. To be fair, analysts expect earnings growth to equal 9.59% over the next five years. If AT&T maintains its dividend yield and meets earnings expectations, the forward P/E of 14.05 is lower than the sum of 9.59% EPS growth and 4.9% dividend yield (14.49%), so the stock appears to be fairly valued via this methodology.

Verizon is the second-highest dividend-yielding stock, and also the second-highest P/E stock in the Dow behind AT&T. Much like its competitor, Verizon reported a loss for the period ending Dec. 31, 2011 of $0.71 a share, bringing its trailing-12-month EPS down significantly. So, we need to do a similar analysis on Verizon to get a normalized earnings picture. The earnings growth rate is 200% if we calcuate the difference between $0.93 and $2.79, but analysts estimate earnings growth of 10.78% over the coming five years. This combined with the 4.5% dividend equals 15.28% growth, which is slightly lower than the forward P/E of 16.02. Using this methodology, Verizon's stock price could rise slightly.

It's unfair to compare Alcoa with either AT&T or Verizon directly, because the latter two companies compete in the telecom sector, and Alcoa is a materials sector company. Unfortunately, due to economic circumstances, Alcoa's price is depressed, which has pushed up its P/E ratio. Earnings are estimated to advance 148.65%, from $0.37 to $0.93 by the end of 2013, so we should again look for a normalized growth estimate on which to base a decision. Analysts expect Alcoa's earnings to grow 13.13% over the next five years. The sum of 13.13% and Alcoa's dividend yield of 1.4% equals 14.53%, higher than the forward P/E of 9.39%. This would rate Alcoa as a buy using this methodology.

Foolish Takeaway
Another method to value growth stocks is to compare stock price appreciation (or depreciation) instead of earnings growth with the forward P/E. The chart below shows each stock's price advance (decline) since January to gauge if price has advanced too far, or can rise further.


Stock Appreciation

Forward P/E

Dividend Yield

















AT&T and Verizon's appreciation percentages combined with their dividend yields are well ahead of their forward P/Es, which means a pullback could be warranted for both stocks. Alcoa is underpriced based on this methodology. While I dislike absurdly high dividend payouts, all three stocks have sufficient cash flow per share to support these payouts, and cash flow is perhaps why these stocks rate as highly for earnings quality as they do. I don't think these stocks' dividends are in jeopardy unless EPS or cash flow suffers in the future. Investors should always base investment decisions on earnings quality.

One of the great things about companies like AT&T or Verizon is the solid dividends they pay, but there are even better ones out there. You can read about them in our special free report: "Secure Your Future With 9 Rock-Solid Dividend Stocks." To see which dividends made the grade, click here now.

Fool contributor John Del Vecchio is co-advisor to Motley Fool Alpha and co-manager of the Active Bear ETF (NYSE: HDGE  ) . You may follow him on Twitter @johnfdelvecchio. He does not own any shares in the companies mentioned in this article. The Motley Fool has a disclosure policy.

Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1937285, ~/Articles/ArticleHandler.aspx, 10/22/2016 4:12:04 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 18 hours ago Sponsored by:
DOW 18,145.71 -16.64 -0.09%
S&P 500 2,141.16 -0.18 -0.01%
NASD 5,257.40 15.57 0.30%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

10/21/2016 4:47 PM
^DJI $18145.71 Down -16.64 -0.09%
AA $26.88 Up +0.19 +0.71%
Alcoa CAPS Rating: ***
T $37.49 Down -1.16 -3.00%
AT and T CAPS Rating: ****
VZ $48.20 Down -0.94 -1.91%
Verizon Communicat… CAPS Rating: ****