Dow Stocks We Can't Live Without

(TheStreet.com, starting Monday and ending Friday, is reviewing all 30 Dow stocks after the index fell 3.1% last month, the steepest drop since February 2009. Six Dow stocks will be featured each day.)

BOSTON ( TheStreet) -- The six Dow stocks ranked halfway between best and worst feature companies that have found their way into most Americans' homes.

AT&T's ( T) wireless service connects Apple ( AAPL) iPhones, Intel's ( INTC) chips power PCs, and Kraft's ( KFT) Cheez Whiz and Oscar Mayer hot dogs provide fuel. All feature "buy" ratings.

>> Dow Stocks: Part 1

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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 Dow stocks based on TheStreet.com Ratings' proprietary quantitative model. The model takes into account financial strength, volatility, growth potential, performance and dividends to project the stocks that are most likely to perform well over the coming year.

#18. Merck ( MRK)

Price-to-Earnings: 11.5 (Pharmaceuticals Average: 30.6)

Debt/Capital: 22.8% (Pharmaceuticals Average: 25.3%)

Price-to-Book: 3.53 (Pharmaceuticals Average: 4.32)

Merck is rated "buy" from TheStreet.com Ratings' model, yet it carries the lowest ranking among Dow pharmaceutical stocks. Pfizer ( PFE) and Johnson & Johnson ( JNJ) rank higher because of stronger financials and less volatility. Still, Merck is secure in its own right.

Merck's stock has risen 34% in the past year, surpassing the S&P 500 while maintaining a relatively low beta value of 0.88. A P/E ratio of 11.5 versus the industry average of more than 30 suggests Merck is undervalued. Pfizer and Johnson & Johnson may have the edge in absolute security, but Merck holds its own and is attractive for investors looking to overweight in pharma.

#17. AT&T

P/E: 11.5 (Telecom Average: 14.5)

Debt/Capital: 41.3% (Telecom Average: 43.4%)

5-Year Geometric Revenue Growth Rate: 28.7% (Telecom Average: 22.7%)

AT&T benefits heavily from its fat dividend yield, which currently hovers around 6.6%, making it one of the heftiest payouts in the Dow, along with competitor Verizon ( VZ), which pays about 6.5%.

AT&T has solid financial strength backing up its big dividend and benefited greatly from its Apple partnership over the past few years. Revenue growth beats the industry's. The company's stock has gained only 3% over the past year, but when the dividend is factored in, the return is closer to 10%. Investors should be leery about AT&T's exclusive contract with Apple over the iPhone, but, for the time being, AT&T is looking be a typical utility bet: big dividend, strong financials and mediocre growth. With low volatility, AT&T is for stock-market bears.

#16. Kraft

P/E: 14.1 (Food Producers Average: 28)

P/B: 1.9 (Food Producers Average: 4.7)

Price/Free Cash Flow: 11.3 (Food Producers Average: 21)

Kraft's stock has lost about 1.4% of its value over the past year. Due to its solid financial footing and the potential for decent growth compared with food producers, it's a good pick. As most producers are trading at a lofty P/E ratio of 28, Kraft has managed to stay fairly valued at a P/E ratio of 14.1. Other valuation metrics like price-to-book value and price-to-free-cash-flow confirm the company's discount pricing.

Kraft's dividend payout yields about 4.2%, and its beta value is low at 0.6, making Kraft a big source of current income with minimal volatility. Investors looking for an explosive turnaround should look elsewhere. Last year didn't offer the type of growth that many other big-name stocks enjoyed, but, based on current valuations, that will occur in 2010.

#15. Intel

P/E: 16.2 (Semiconductor Average: 141.5)

Debt/Capital: 5% (Semiconductor Average: 23.8%)

P/FCF: 22.2 (Semiconductor Average: 47.2)

Intel's stock, which has risen 43% over the past year, scores a 9.9, the highest possible, in the financial-strength category, suggesting it has the fundamentals to back up the rise. Compared with its chief rival, AMD ( AMD), Intel is in a different stratosphere when it comes to financial security.

That solid financial positioning has led to a stable share price. A beta value of 1.14 shows that the stock is only slightly more volatile than the market is. Intel, ranked halfway between No. 1 and 30, is the first stock in the Dow to score a B in the ratings grade.

#14. Walt Disney ( DIS)

P/E: 16.2 (Media Average: 30.5)

Debt/Capital: 26.4% (Media Average: 75.6%)

P/B: 1.6 (Media Average: 4.8)

Disney had quite a 2009. The company acquired Marvel, tacked on nearly 43% to its share price and was nominated for a Best Picture Oscar for its latest Pixar offering, "Up," a purchase that continues to prove its value. Priced at a discount to other media companies with a P/E ratio of 16.2 versus the industry average of 30.5 makes Disney look like a steal.

Disney's dividend yield isn't as high as other Dow stocks at 1.2%, but, what it lacks in current income, it makes up for in total return as it handily beat the S&P 500 over the past 52 weeks. Entertainment isn't an easy industry to excel in during a recession because consumers are guarding their wallets even more carefully. Disney has managed to weather the storm nicely. Its low leverage compared with the industry has helped the company fend off losses and helps its ratings since TheStreet.com Ratings model is sensitive to high leverage, or borrowing.

#13. Microsoft ( MSFT)

P/E: 15 (Software Average: 30.5)

P/FCF: 13.5 (Software Average: 25.8)

Debt/Capital: 12.7% (Software Average: 16%)

Apple gets all the headlines, but Microsoft is still the dominant name in computer platforms. Microsoft's stock has climbed about 60% over the past year and still remains priced at a discount to most other software companies based on earnings and free cash flow. Certainly, the netbook craze hasn't hurt profits as the company reaps the benefits of most households owning several computers.

A return on equity of about 37% provides the backing for much of the run-up as solid financials confirm that the value assigned to the stock is legit. Microsoft has a higher growth score than all but five of the Dow components, suggesting the company is becoming even bigger and more ingrained in the software market. Windows 7 and Bing came out in 2009, one to fix a major sore spot and the other to take on a rival for world domination, and both have helped Microsoft regain former customers and reach new markets where it can throw its weight around.

The six companies reviewed above are the lifeblood of the Dow, huge companies that have reached a critical mass that will only be stopped by a black swan event.

-- 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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