I figured it out. The settings.php called “featured1” not “featured” as the name of the field. So I changed that in the code above
from
query_posts('showposts=4&cat=' . get_cat_ID(dp_settings('featured')));
to
query_posts('showposts=4&cat=' . get_cat_ID(dp_settings('featured1')));
Now I can sort by category. Very frustrating, but fixed now.