Win in 2012 With the Dow's Underdogs?

Late last year, I introduced readers to a strategy for beating the Dow created by Charles Carlson, CEO of Horizon Investment Services and author of several books on investing. Read below to see how you could use Carlson's strategy to profit, and at the end I'll offer up access to a special free report on the stocks only the smartest investors are buying now.

The strategy
Borrowing liberally from what I wrote in November, here's how Carlson's strategy works:

  1. Find out which five stocks in the Dow Jones Industrial Average have performed the poorest over the past year.

  2. Buy those five stocks (forcing you to buy low).

  3. Hold them for one year.

  4. Sell those stocks (forcing you, theoretically, to sell high).

  5. Wash, rinse, repeat...

Carlson ran the numbers: "What I discovered was that buying a basket of the Dow's worst-performing stocks (I call these underachieving stocks 'Dow underdogs') and holding them for a year outperformed the Dow by a wide margin going back to 1930."

The strategy didn't work too well in 2011, as the Dow's underdogs had a return of -32% versus a return of more than 5% for the broader Dow exchange. You could either say this proves that the strategy doesn't work or see it as a sign that now's the time to buy into the strategy -- as it is now charged for even better returns as it reverts to its market-beating mean.

Either way, here are the five companies that qualify for 2012, along with a little info on what other Fools are saying about each company's prospects.

Cisco (NAS: CSCO)
Having lost 10.6% of its value in 2011, this tech giant is hoping for better things in 2012. Cisco only recently joined the ranks of dividend-paying companies, and with a low 16% payout ratio, there's tons of room for growth in dividends.

And while fellow Fool Rich Smith thinks the company is facing some pretty serious challenges, he concedes that those challenges are creating a stock that's priced for the bargain bin right now.

Hewlett-Packard (NYS: HPQ)
Oh my, what a terrible two years it's been for HP. First Mark Hurd leaves, and then there was the Leo Apotheker fiasco. Now it's under the leadership of Meg Whitman, and investors are praying for returns that will best last year's dismal -39% showing.

Award-winning Fool Morgan Housel seems to think now might be the right time to buy HP. As he explains, "HP stock is almost comically cheap. If the company spent all of its annual free cash flow on share buybacks, it would repurchase itself entirely in about six years."

Alcoa (NYS: AA)
One of the world's biggest aluminum producers, Alcoa had a rough 2011: Shares were down 44%. And the company's already off to a rough start in 2012. Although it beat revenue estimates for the fourth quarter, it came in short on earnings.

Unfortunately, because of a terrible confluence of factors, Fool contributor Sean Williams doesn't think this year will be a good one for the company: "Depressed aluminum prices are making it absolutely impossible for it and its closest peers to turn a meaningful profit. "

Bank of America (NYS: BAC)
No Dow stock suffered more in 2011 than Bank of America, which was down 58%. A European debt crisis, mortgage problems on the balance sheet, and a PR debacle over debit cards are all to credit for a horrendous year.

But Fool Anand Chokkavelu is positively bullish on Bank of America in 2012. Though Anand realizes "book value" may not mean the same thing now that it once did, he states, "Bank of America trades at just a third of book value. In the decade before the financial crisis, Bank of America never once traded at even book value."

JPMorgan Chase (NYS: JPM)
Along with Bank of America, this other big banker didn't have too much to brag about in 2011: Shares were down 22%. All was not lost, though, as Fool Dan Caplinger points out: "The bank was able to quintuple its dividend earlier this year and is making big profits from wide interest rate spreads."

As far as 2012 goes, it didn't get off to a good start. JP's fourth-quarter earnings fell by 23%. That's not a great start in what will be a make-or-break year for the bank.

Foolish final thoughts
As I stated last November, this style of investing isn't for me. I like researching my own stocks and buying them to hold for the long run -- not just one year.

Recently, our analysts created a new special free report: "The Stocks Only the Smartest Investors Are Buying." One of the five companies profiled here made the list. Find out which one by getting your copy of the report today, absolutely free!

At the time thisarticle was published Fool contributor Brian Stoffel does not own shares of any of the companies mentioned. You can follow him on Twitter at @TMFStoffel.The Motley Fool owns shares of JPMorgan Chase, Bank of America, and Cisco Systems, and has created a bull call spread position on Cisco Systems. Motley Fool newsletter services have recommended buying shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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