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Dow Stocks -- The Top Six Picks

Dow stocks represent the pinnacle of American business. Here are the six most highly rated Dow stocks, according to an analytical model that takes emotion out of the equation.

BOSTON (TheStreet) -- There are no losers in the Dow Jones Industrial Average. Dow stocks, even those with the lowest ratings, are like students admitted to Harvard Business School -- you have to be among the best to get in.


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Dow stocks

are the oft-cited gauge for equity performance in the U.S. and targets for many large-cap fund managers. The simplest way, in theory, for a manager to best the market would be to buy the market but kick out the least attractive

Dow stocks


Picking the top-performing

Dow stocks

is no easy task. This week we're ranking

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TheStreet Recommends

Dow stocks

based on Ratings'

proprietary quantitative model. The model takes into account financial strength, volatility, growth potential, performance and dividends to project those most likely to perform well over the coming year.

Today's selection is the cream of the crop. This group features all-around quality companies that receive at least a B-plus from Ratings'




(IBM) - Get International Business Machines Corporation Report

P/E (price-to-earnings): 12.6 (Technology Average: 32)

P/S (price-to-sales): 17 (Technology Average: 4.8)

P/FCF (price-to-free cash flow): 9.5 (Technology Average: 23.9)

Big Blue comes in at No. 6 with a grade of B-plus and a "buy" rating based on solid numbers all around. The stock has climbed about 36% over the past year and is still undervalued compared with competitors. The technology company saw only a slight slowdown in its performance trends despite the deepest economic recession in 80 years.

The company's dividend, currently yielding about 1.8%, is attractive, yet isn't nearly as beefy as some of its fellow Dow components. IBM should be a good bet going forward as it's attractively priced and manages to stay profitable even in adverse economic conditions. Like many other Dow stocks, IBM quickly jumped off the mat from its lows as investors realized that the company was still fundamentally sound and overly punished in the turmoil of 2008 and early 2009.


Procter & Gamble

(PG) - Get Procter & Gamble Company Report

P/E: 16.6 (Consumer Goods Average: 22.8)

Debt/Capital: 36.9% (Consumer Goods Average: 43.3%)

P/FCF: 13.1 (Consumer Goods Average: 21.9)

Procter & Gamble's brands are ubiquitous. If you've ever bought Duracell batteries, Gillette razors, Dawn dish soap, Tide detergent or Crest toothpaste, you've added to P&G's revenue. This incredible product lineup has led to the company being incredibly steady -- its beta value is only 0.68.

The ratings model gives Procter & Gamble a score of 9.9 (out of 10) for financial strength, indicating a rock-solid financial position. The company's dividend yields 2.8%, about average for Dow components. After climbing 22% in the past year to reclaim its 2007 valuation, the stock may ease off as it moves in line with the industry average. Even without explosive growth, Procter & Gamble is a safe bet that offers returns close to that of the broader stock market.



(WMT) - Get Walmart Inc. Report

P/E: 15.5 (Retail Average: 21.4)

P/S: .52 (Retail Average: 1.02)

P/FCF: 16.2 (Retail Average: 18.2)

Even BMW drivers shopped at Wal-Mart to save a few shekels during the recession, a trend that aided the uber-discount retailer. Ratings'

model doesn't think in terms of consumer behavior, but still likes Wal-Mart based on the fundamentals.

The model loves the company's stable financial position and super-low volatility, which can be seen in its tiny 0.65 beta value. The stock has increased only 18% over the past year, well below the market as a whole, but the reason for the underperformance is due to the fact that the shares didn't collapse in the first place. In fact, by looking at Wal-Mart's price chart, it would be difficult to pick out the dates when the stock market fell apart since there are only tiny blips in Wal-Mart's price at those times. Wal-Mart is almost like a risk-free equity security now. Adding it to your portfolio offers protection against adverse market conditions. Indeed, the shares are up 1.5% this year, while the S&P 500 has fallen almost 5%.



(TRV) - Get Travelers Companies, Inc. Report

P/E: 8 (Insurance Average: 30.3)

Debt/Capital: 19.2% (Insurance Average: 37.3%)

P/B (price-to-book value): .96 (Insurance Average: 1.4)

Travelers made its way into the Dow after


(C) - Get Citigroup Inc. Report

was dropped due to its implosion. The switch is exceedingly ironic since Citigroup spun off Travelers in 2002 due to the risks that Travelers faced from underwriting activity was weighing on Citigroup's share price. Now the supposedly more risky Travelers was replacing Citigroup, which was shaking under its own risk exposure.

Travelers has risen the most out of the top-rated Dow stocks over the past year. The shares have jumped 34%, yet posts a beta value of just 0.82. The company scores only a 7.9 on the financial-strength scale, 2 full points below the other top six Dow stocks, but based on the liabilities an insurer faces, that score is still very good. A dividend currently yielding 2.6% is also a strength.


Johnson & Johnson

(JNJ) - Get Johnson & Johnson Report

P/E: 13.7 (Pharmaceutical Average: 30.5)

Debt/Capital: 21.8% (Pharmaceutical Average: 26.7%)

P/FCF: 13.9 (Pharmaceutical Average: 26.8)

Johnson & Johnson finishes at #2 on the list and is the first stock featured to earn a grade of A-minus. The company easily outpaces its pharmaceutical competition,


(MRK) - Get Merck & Co., Inc. Report



(PFE) - Get Pfizer Inc. Report

, through stable performance, growth and rock-solid financials. The stock has risen about 13% over the past year. It was one of the few companies in the Dow that floated above the carnage of 2008.

Johnson & Johnson's diversification from pharmaceuticals has greatly improved the company's risk profile and makes it a good cornerstone investment. The company has a dividend that yields about 3.1% and features a beta value of 0.68 on top of some very attractive value multiples.



(MCD) - Get McDonald's Corporation Report

P/E: 16.4 (Restaurants Average: 31.7)

P/FCF: 18.8 (Restaurants Average: 25)

Profit Margin: 20% (Restaurants Average: 3.7%)

McDonald's takes the top spot. The fast-food giant scores phenomenally well in every category that the model takes into consideration. Solid growth, good performance with low volatility, strong financials and a big dividend lead to a grade of A and a "buy" rating.

McDonald's has risen 15%, with a beta of just 0.66, over the past year and sports a profit margin a full 16 percentage points higher than the industry average. You may disagree with the company's impact on the waistlines of Americans, but you can't argue with those financial figures.

Investing equally in the top-four-rated Dow components two years ago would have given you a 13% gain. Over the same period, the Dow lost 36% of its value, while the S&P 500 sank 35%. While the past two years have been anomalous, investors would do well to stick a healthy amount of their equity allocation in stable stocks like these. As the saying goes: No one has ever been fired for buying IBM. You can add Procter & Gamble, McDonald's, Johnson & Johnson, Travelers and Wal-Mart to that list.

-- Reported by David MacDougall in Boston.

Prior to joining Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.