• UBS has a list of large-cap dividend payers it has dubbed UBS Dividend Ruler Portfolio that comprises of stocks with above-average dividends.
• The portfolio has outperformed the S&P 500 over the long-term. The tables, however, turned in 2015 with the portfolio trailing the market.
• UBS says the portfolio is likely to outperform the market in 2016.
• Which stocks are the best candidates for good returns in this portfolio?

UBS has compiled a basket of top blue chip dividend paying stocks which it has dubbed UBS Dividend Rulers Portfolio. The company created the list in 2003 and features 28 blue chip stocks that above-average dividend yields (˃ 2%). The list comprises well-known names including Microsoft (NASDAQ: MSFT), Intel (NASDAQ: INTC), Texas Instruments (NASDAQ: TXN), Boeing (NYSE: BA), Home Depot (NYSE: HD), McDonalds (NYSE: MCD) and Pepsico (NYSE: PEP), among other top stocks. Coca Cola (NYSE: KO) made a comeback on the list after being swapped out with British American Tobacco (NYSEMKT: BTI) in 2014.

Investors will notice that companies in the UBS list are all mature companies whose top line growth has almost flat-lined or is in reverse mode in some cases. A certain group of investors typically prefer investing in such stocks due to their slow but steady stock returns, and the fact that these stocks tend to far less volatile than stocks of younger growth companies. Over the long-term, stocks in UBS Dividend Rulers Portfolio have handily outperformed the market: stocks in the list sport a collective average return of 201% since the list was created 12 years ago vs. 158.5% for the S&P 500 over a similar timespan.

But the tables turned in 2015. The UBS Dividend Rulers Portfolio returned -5.4% vs. +6.5% gain by the S&P 500 (as at November 30). To be fair, the outsized gain by the UBS Portfolio in 2014 when it returned 26% certainly played a part in those returns. UBS says that the situation will revert to the norm in 2016 as the headwinds that hampered the performance of these large-cap dividend payers largely easing up. Meanwhile, the analyst say that increase in Fed rates is unlikely to have a large impact on the performance by these stocks.

It’s unfortunate that investors cannot invest in the UBS Dividend Rulers Portfolio as a basket since there is no such an ETF available in the market to the best of my knowledge. Investors can, however, still invest in individual stocks in this list. So, which are the best stock picks here?

My top picks in the UBS list are Microsoft and Boeing.

1. Microsoft Stock (MSFT)

Microsoft stock has been the best-performing in the UBS Dividend Rulers Portfolio both over the short-term and long-term. Here is how Microsoft stock compares to the portfolio:

Microsoft’s revenue growth has been on a decline--down 6.5% Y/Y during the last quarter--due to the company’s ongoing transition from an on-premise software model to a cloud-subscription model. The investing world, however, seems to love Microsoft stock because the company’s cloud is currently growing fastest among all major cloud vendors. Microsoft’s commercial cloud revenue expanded in triple-digits during the last quarter and is currently on an $8B+ annual revenue run rate, or ~10% of Microsoft’s revenue.

Microsoft’s revenue contraction mainly stems from the fact that the company is mostly giving away free copies of its Windows OS cash cow. But once the company builds a huge user base of its cloud, it will then have a good chance to monetize its numerous other cloud services.

Microsoft’s stock is also likely to receive a better valuation as it continues to transition to the cloud. This has been the case with Adobe Systems (NASDAQ: ADBE), the first company to successfully complete the move from a traditional software company to a cloud company. Four years ago, Adobe stock sported a PE ratio of 25; now its PE ratio has skyrocketed to 97.7. Microsoft stock sports a PE ratio of 37.7 implying there is ample room for improvement here.

2. Boeing Stock (BA)

Boeing is another UBS Dividend Rulers Portfolio stock that has put up remarkable performance, even managing to outperform Microsoft stock over a 5-year period. Here is how the giant airline manufacturer’s stock performance compares to the portfolio:

Boeing stock has been benefiting from a resurgence in air travel which has resulted in many airlines placing many more orders for new aircraft. Boeing has also demonstrated an ability to design and make highly-fuel efficient aircraft such as the Dreamliner 787, which until the recent precipitous drop in fuel prices was a strong selling proposition. Fuel expenses are usually the biggest line item for a major airline, and a fuel-efficient aircraft can result in real cost savings that trickle to the bottom line.

Boeing has lately cut back on capex on its its loss-making Dreamliner, and has also predicted that the aircraft will soon become profitable. This should provide a nice boost to the company’s free cash flow as well as its bottom line.

Boeing stock recently tanked almost 10% after some Wall Street analysts said that the prevailing low oil prices, as well as interest rate hikes by the Fed, are likely to hurt the company. Boeing stock was also hurt by comments by Delta Airline’s CEO that the company had purchased used Boeing 777 jets for a song. I discussed these issues at length in this article here.

In the article, I explained that low oil prices is likely to act as a short-term headwind for Boeing since it might encourage more airlines to put off purchase of new aircraft. But I explained this is only likely to affect Boeing’s sales over the short-term due to the fact that the company has a huge order backlog that will take it something like eight years to work through. An airline cannot be sure what the prices of oil will be eight years from now. And ultimately airlines need to replace their aging fleets whether oil prices remain low or not.

Boeing’s long-term outlook is likely to be influenced by how fast the air travel business grows, and current forecasts are good.