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Looking for Bargains Hidden in the Dow's Record Run

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Though the Dow Jones Industrial Average appears ready to hit new highs, can investors still find good deals?

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The Dow Jones Industrial Average (INDEXDJX:.DJI) is climbing back to its all-time high of 16,576.55 set on December 31, 2013. The index, which lists relatively few stocks, has an outsized impact on investor psychology. Why? Because the stock pickers at Dow Jones & Co. only select the largest, most profitable companies to follow.

The average is price-weighted, which gives higher-priced stocks more influence over the average than their lower-priced counterparts. In layman's terms, the stocks at the top of the average move the index more than stocks at the bottom.

The Idea
So? So the bottom of the average appears to underperform, even though the financial fundamentals of those companies may be sound.
That's not to say that a poorly performing stock listed on the Dow Jones index is always an unappreciated Cinderella with no date to the dance. Poor stock price performance might be a sign of a poor investment. But stocks that consistently underperform get kicked out of the index -- see Alcoa (NYSE:AA), Bank of America (NYSE:BAC) for details). Last year's laggard can turn out to be next year's leader.

The bottom third of the DJIA this year includes AT&T (NYSE:T), Caterpillar (NYSE:CAT), Chevron (NYSE:CVX), Cisco Systems (NASDAQ:CSCO), Travelers Companies Inc. (NYSE:TRV), Goldman Sachs (NYSE:GS), IBM (NYSE:IBM), McDonald's (NYSE:MCD), Coca-Cola (NYSE:KO), and, bringing up the rear, General Electric (NYSE:GE), which posted a miserable 8% share price decline for 2013.

You've heard of these companies -- heck, in 2013 you probably consumed their products on more than one occasion. (OK, maybe you didn't buy a backhoe or arrange a multibillion-dollar merger, but you did drive on a road and you probably patronized a business that did a major banking deal.)

The List

To find out which Dow components are good value investments and which ones might end up in the dustbin of history, we screened the 10 stocks above looking at several metrics. Did investors increase or cover their short positions in the last month? Which businesses became more profitable in 2014? Is a company's enterprise value low relative to its levered free cash flow? Last but not least, does a stock's Graham number indicate it's undervalued?

Investors are giving Caterpillar a big thumbs-down and increasing their short positions in the stock. AT&T, on the other hand, stands out relative to the other stocks in the screen for its increase in profitability. Cisco appears to be undervalued by its EV-LFCF ratio, and Chevron gets a thumbs up from Mister Graham.

Moreover, as the chart below demonstrates, half of the 10 have price of profit (POP, a.k.a. forward P/E) ratios below 12, and three have POP ratios at 10, which is another way of saying they are bargains.


Click for interactive chart


1. AT&T, Inc.: Provides telecommunication services to consumers, businesses, and other service providers worldwide. Market cap at $168.54 billion, most recent closing price at $31.94.

2. Caterpillar Inc.: Manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide. Market cap at $62.01 billion, most recent closing price at $96.80.

3. Chevron Corporation: Engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. Market cap at $219.92 billion, most recent closing price at $114.75.

4. Cisco Systems, Inc.: Designs, manufactures, and sells Internet protocol (IP)-based networking and other products related to the communications and information technology industry worldwide. Market cap at $116.1 billion, most recent closing price at $21.95.

5. General Electric Company: Operates as a technology, service, and finance company worldwide. Market cap at $255.28 billion, most recent closing price at $25.38.

6. The Goldman Sachs Group, Inc.: Provides investment banking, securities, and investment management services to corporations, financial institutions, governments, and high-net-worth individuals worldwide. Market cap at $76.04 billion, most recent closing price at $163.86.

7. International Business Machines Corp.: Provides information technology (IT) products and services worldwide. Market cap at $197.4 billion, most recent closing price at $185.08.

8. McDonald's Corp.: Operates as a foodservice retailer worldwide. Market cap at $95.82 billion, most recent closing price at $95.03.

9. The Coca-Cola Company: Distributes, and markets nonalcoholic beverages worldwide. Market cap at $167.01 billion, most recent closing price at $37.96.

10. The Travelers Companies, Inc.: Provides various commercial and personal property and casualty insurance products and services to businesses, government units, associations, and individuals primarily in the United States. Market cap at $29.96 billion, most recent closing price at $83.38.

Editor's note: This story by Will Kenton originally appeared on Kapitall.

Kapitall's lists break complex concepts down to their basics, offering education and investing ideas to novices that double as a refresher course for more seasoned investors. Inspired by video game design, Kapitall's revolutionary brokerage platform combines a graphical user interface with tools that make it easy to build portfolios, share ideas and execute trades.

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No positions in stocks mentioned.
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