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The 10 most attractive Dow stocks Add to ...

The Dow Jones Industrial Average is no longer a bargain, according to one fundamental valuation measure. As of Friday's close, the liability-adjusted cash flow yield (the anticipated rate of return through which all of a company's debts and liabilities are proportionally assumed into the purchase price of the stock) of the SPDR Dow Jones Industrial Average ETF is 4.03 per cent. Divide this figure by the 2.82 per cent yield of a 10-year U.S. Treasury Note and the resulting margin of safety ratio is a scant 1.43 (a ratio greater than 2 is desirable).

In light of these figures, bond and index fund investors should prepare for total-returns below historical averages. However, "stock pickers" should be able to generate satisfying long-term returns by selecting equities with attractive valuations, strong returns on invested capital and a durable competitive advantage.

Last week we focused on the 10 Dow stocks with the least attractive valuations -- a portfolio of companies that suffer from weak or irregular cash-flows, excessive debt burdens, and possibly, a damaging speculative interest. This week we highlight the 10 Dow stocks with the largest (most-attractive) liability-adjusted cash-flow yields (using 10-year historical data).

Some of these stocks may trade at valuations that scream "buy," but remember, the true merit of any investment rests in the stability (and ideally, growth) of future cash flows. In this regard, you the investor must form your own considerations and conclusions.

10. 3M

Liability-Adjusted Cash Flow Yield: 4.4 per cent

10-Year Treasury Yield: 2.82 per cent

Margin of Safety Ratio: 1.56

Return on Invested Capital: 22 per cent

Dividend Yield: 2.4 per cent

3M is a great company trading at a fair price. This "Dividend Aristocrat" has delivered stable returns for investors for the last three decades. With a 22 per cent return on invested capital (no easy feat for a $62-billion company), the manufacturer of Post-Its and Scotch Tape continues to deploy capital wisely.

At a March 2009 low of $41.83, 3M was a slam dunk investment. At around $90, 3M is no longer a bargain, but is still among the most attractively priced stocks in the Dow (and arguably, a better income investment than U.S. debt).


9 . Hewlett-Packard

Liability-Adjusted Cash Flow Yield: 5 per cent

10-Year Treasury Yield: 2.82 per cent

Margin of Safety Ratio: 1.77

Return on Invested Capital: 22 per cent

Dividend Yield: 0.7 per cent

Hewlett-Packard's stock is in a multiyear convalescence following the theatrics surrounding the HP-Compaq merger of 2001 and the forced departure of Carly Fiorina -- an embattled and unloved CEO.

H-P has delivered strong (albeit inconsistent cash flows) for the last five years, but forward-looking investors must consider the company's mobile strategy. Earlier this year, H-P acquired Palm for $1.2-billion (presumably, for Palm's WebOS) -- but at this point, H-P's role in the mobile revolution is unclear.

The computing giant's valuation is among the bottom third in the Dow, but does not fully discount the uncertainty surrounding the future (and competitiveness) of the mobile computing landscape.

8. IBM

Liability-Adjusted Cash Flow Yield: 5.4 per cent

10-Year Treasury Yield: 2.82 per cent

Margin of Safety Ratio: 1.91

Return on Invested Capital: 40 per cent

Dividend Yield: 2 per cent

Since the 1970s, both IT managers and money managers have spoken a now-classic adage, "Nobody ever got fired for buying IBM ."

Long considered a defensive stock, IBM has shifted back into growth mode, delivering impressive year-over-year cash flow gains since 2006. Assuming that the IT bellwether can continue growing cash flows into the future, IBM makes for a very compelling investment at today's valuation (despite being near a 10-year high).

Yet for the average investor, IBM almost certainly falls into the category of too-complex-to-understand. The company's blend of hardware, software and outsourcing products is both global and robust, but a truly cautious investor should heed Warren Buffett's advice -- don't buy what you don't understand.

7. Cisco

Liability-Adjusted Cash Flow Yield: 5.5 per cent

10-Year Treasury Yield: 2.82 per cent

Margin of Safety Ratio: 1.95

Return on Invested Capital: 55 per cent

Dividend Yield: N/A

Cisco is a "no-longer-sexy" tech company that deserves far more love than it receives. The $140-billion data-networking giant delivers a 55 per cent return on invested capital (an extremely high figure for a company that makes physical goods), strong (and growing) cash flows, and holds nearly $40-billion in cash and cash equivalents.

After a precipitous decline following the dot-com crash, Cisco's shares have failed to break out of a trading range -- but patient investors have something to look forward to: Cisco CFO Frank Calderoni has recently affirmed his commitment to rewarding shareholders with a dividend.

In the meantime, Cisco's share repurchase program should deliver value to shareholders (considering the company's below-average valuation).

6. ExxonMobil

Liability-Adjusted Cash Flow Yield: 5.5 per cent

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