The Dow Jones Industrials (^DJI 0.31%) have had a banner year in 2013, climbing more than 25%. But even with that strong performance, IBM (IBM +0.58%) and Caterpillar (CAT 0.05%) have largely missed out on the Dow's strong performance, with IBM having posted a loss for the year and Caterpillar rising just 3%. Some value investors have started gravitating toward those beaten-down stocks, arguing that they're due for a rebound. But does history bear that theory out? Let's take a look at the past performance of lagging Dow stocks and what it says about the following year.
How 2012's laggards did
The idea that a bad year for a stock's performance should result in a future good year is a popular one, especially among investors in solid companies with little threat of permanent failure. In the business world, many trends are cyclical, and out-of-favor stocks often come back into favor and bring huge returns to those who had confidence in their turnaround stories. That hope is what's making bottom-fishing investors look at Caterpillar and IBM as prospective improving investments for 2014.
Certainly, high-profile turnaround stories have happened in the past. In 2012, former Dow component Hewlett-Packard (HPQ 0.14%) had horrific performance, plunging 43% as disasters like its $8.8 billion charge from its acquisition of Autonomy, key employee departures, and a general lack of confidence sent investors running for cover. Yet HP stock has doubled in 2013, recovering all of 2012's losses and then some as HP's turnaround strategy finally began to take shape and boosted confidence in the tech giant's future prospects.
Yet success for other Dow laggards in 2012 was more modest. Intel (INTC +5.44%) jumped 29% in 2013, outperforming the Dow by a few percentage points and regaining the ground it lost from its 12% decline in 2012. New CEO Brian Krzanich emphasized the value of Intel's production capabilities, opening the door to producing more chips for outside manufacturers rather than solely emphasizing its own proprietary designs. Still, even though the company did make solid progress on the mobile-chip front in 2013, Intel has a long way to go before it can find its best mobile niche in the already-crowded industry.
For McDonald's, the story has been even less encouraging, with just a 14% rise in 2013 following 2012's 9% drop. The fast-food giant has faced continuing struggles with its overseas operations, as an avian-flu scare in China has weighed on growth. Yet more troubling is the rising perception of McDonald's as having issues with customer service, as some workers struggle with expanded menus and the greater skill sets required in making premium beverages and other demanding tasks. As consumers look for healthy food offerings, McDonald's hasn't yet found a way to recast its image of meeting the needs of health-conscious customers.
A long time coming
Even IBM and Caterpillar themselves point to the fact that a bounce-back from poor performance isn't a sure thing. Caterpillar rose only 2% in 2012, but persistent poor conditions in the construction industry, combined with new challenges among mining companies in the face of plunging commodities prices, have extended the heavy-equipment maker's poor performance. Caterpillar itself sees weak conditions potentially lasting for years, putting a ceiling over the stock's appreciation potential.
Similarly, IBM gained only 6% in 2012, and this year's negative returns stem from Big Blue's transition to a new CEO and a strategy more focused on providing IT services and software over its traditional hardware emphasis. With IT spending among businesses having been weak for years, IBM has struggled to fight off tough competition from a host of companies, many of which have made direct assaults on what have historically been IBM's areas of strength.
IBM and Caterpillar are likely to recover eventually, as they've both shown histories of bouncing back from cyclical downturns. But you shouldn't necessarily count on their posting the strongest returns among the Dow stocks in 2014. Sometimes, it takes longer for turnarounds to make themselves complete.
