Three Best Dow Stocks for 2010

BOSTON ( TheStreet) -- Investing in companies that are members of the Dow Jones Industrial Average isn't going to make anyone rich. If that were the case, the U.S. would swell with millionaires, and investment managers would be out of work.

Dow stocks are too big and widely traded for investors to find deep value that others have missed. In a way, the 30 companies are the stock market. Stocks such as Wal-Mart ( WMT), Microsoft ( MSFT) and General Electric ( GE) rarely beat indexes by leaps and bounds. They can, however, offer stability after a year in which U.S. stocks fell by more than half from their peak and then rocketed more than 60% from a low in March.

Dow cornerstones provide a stable base and offer a fair amount of current income because most member companies pay relatively large dividends. Both AT&T ( T) and Verizon ( VZ) pay dividends that yield over 5%, more than that of the benchmark 10-year Treasury bond.

Here are three Dow stocks that could serve as a backbone and a growth catalyst for a portfolio. America most likely will see cautious optimism return this year after the deepest recession in 80 years. International diversification is key, since emerging markets are projected by economists to outstrip U.S. growth.

Johnson & Johnson ( JNJ): Merck ( MRK) and Pfizer ( PFE), other pharmaceutical companies in the Dow Jones Industrial Average, don't have much going on outside of the drug game. Drugs represent about a third of Johnson & Johnson's business. With a strong consumer-products division and a medical-device unit that makes everything from contact lenses to joint replacements, Johnson & Johnson is insulated from the disastrous risk of a weak drug pipeline.

Additionally, Johnson & Johnson generated 49% of its revenue from the U.S. in the third quarter, indicating that a faltering or lagging economy won't severely damage the company.

Johnson & Johnson has a dividend yield of 3% and a return on equity (ROE) of 26.6%, showing solid profitability over the previous 12 months. Analysts predict 2010 revenue growth of nearly 5% and earnings growth of almost 8%.

IBM ( IBM): With 35% of revenue coming from the U.S., IBM is even less dependent on a strong dollar than Johnson & Johnson is. Actually, a weaker dollar helps IBM, as it gets more of the U.S. currency when trading in a stronger euro or yen.

Profitability hasn't been hard to come by, even during the recession. With a ROE of 56.8% for the trailing 12 months, IBM has continued to satisfy investors through the downturn. As the economy starts to thaw, companies should once again start plowing money into investment projects, leading to increased spending on computer consulting and systems. IBM pays a dividend of 1.7%.

Exxon Mobil ( XOM): Exxon had a dismal 2009. The energy giant's stock price dropped 14% as oil rose but didn't come close to reaching the heights hit in 2008. A dividend yield of 2.4% helped pare losses. This year could see renewed vigor in energy prices as a global economic expansion gets going. Analysts are predicting revenue growth of 35% for Exxon.

Continuing with a focus on international diversification, Exxon is the least tethered to the U.S. Three-quarters of its revenue is booked abroad.

With the acquisition of natural-gas company XTO Energy, Exxon is steering away from oil. That's a positive for investors, as Exxon clearly is showing a forward-looking stance.

In addition to their individual merits, Johnson & Johnson, IBM and Exxon work together well to decrease risk. Johnson & Johnson's correlation with IBM is just 0.56, suggesting only a small link between the two. Its correlation with Exxon is even lower at 0.49. Exxon and IBM are more strongly correlated at 0.72, but they still offer diversification benefits. Alone or together, the three companies are purpose-built for 2010.

-- Reported by David MacDougall in Boston.

Prior to joining TheStreet.com 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.

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