The 1 Not-So-Hidden Weapon of Top Dow Stocks

Before you go, we thought you'd like these...
Before you go close icon

The Dow Jones Industrial Average (INDEX: ^DJI) comprises some of the greatest companies of our time. All 30 components pay a dividend, and many are considered the safest investments on the market. The Dow is arguably the most tracked of the major indices, and it's regarded as a fair barometer of the overall stock market's health.

Yet despite this perceived stability, there are still hugely disparate returns within the index. In just this year alone, Bank of America (NYS: BAC) has run up an astonishing 75%, while Hewlett-Packard has lost a disappointing 8.5%.

So I set out to learn what separated the dogs from the darlings.


The foolish view
As a long-term Foolish investor, I wasn't interested in year-to-date performance. I wanted the real deal, so I looked at how each Dow stock has performed over the past decade. The results were striking. The spread from the best to the worst return was a sky-high 433%. Here's a look at the top three and bottom three performers.

Company

10-Year Return

Caterpillar (NYS: CAT) 365%
McDonald's349%
Chevron227%
General Electric (NYS: GE) (25%)
Bank of America(60%)
Alcoa (NYS: AA) (68%)

10-year return assumes dividend reinvestment.

So what do Caterpillar and McDonald's have that Alcoa and Bank of America don't? The answer is hidden in plain sight: brand strength.

Who's got it
By nature of being intangible, brand strength is subjective and difficult to calculate. I therefore deferred to the pros at Interbrand, whose annual ranking of the top 100 global brands is the de facto brand-strength baseline.

The company calculates that top performers Caterpillar and McDonald's have brand strengths of $6 billion and $36 billion, respectively. While about half of the Dow components made the top 100 list, bottom performers Bank of America and Alcoa didn't. The majority of the Dow brands that made the list are in the top 15 performers of the past decade, and they command an aggregate brand value of about $50 billion more than the bottom 15 companies (of those that we're ranking). If Hewlett-Packard moved up even one spot, this spread would have grown to $106 billion. The top three brands on the list are all Dow components, as are eight of the top 10 ranked companies.

The value of a brand
The good news for investors is that brands matter to the bottom line. A McKinsey Quarterly study once showed that strong brands cause people to make more frequent visits, spend more, and pay premiums. A StrategiCom study also concluded that "the evidence [does] point to the fact that in most industries, having better perceived brand strength generally [does] correlate to having a higher share returns."

Interbrands rankings also confirms this finding. The total five-year return of the five most valuable brands on this list in an equally weighted portfolio would have returned 51%, compared with just 14.5% for those ranked 95-100. I went with a five-year return because Google is a top-rated brand but only went public in 2004.

How to use it
It's not an absolute correlation, though. Brand wunderkind General Electric has been in the top five most valuable brand rankings for the past decade, yet it was one of the worst-performing Dow components over the same period. The implosion of GE Capital is the obvious culprit here. Backing out the decade's performance up to the financial crisis, General Electric would have been seen outperforming its peers by a wide margin.

In addition, the most valuable brand here was not the best-performing Dow stock of the past decade. So as investors, you shouldn't use brand strength as super-metric for determining your investments. Instead, it should be a bullet in your investing chamber, giving you extra conviction or skepticism about a certain company. Maybe you pay a little more in terms of valuation for a company with a strong brand, but looking at these long-term returns, I'd say it's worth it.

At the time this article was published Austin Smith owns shares of McDonald's. The Motley Fool owns shares of Google and Bank of America.Motley Fool newsletter serviceshave recommended buying shares of Google, Chevron, and McDonald's. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners