The Dogs of the Dow Strategy

The Dogs of the Dow Strategy 

Over the years, there have been many self-professed “gurus” who claim to know the secret to profitable stock market investing. While some of these experts have earned gains with their varied techniques, there is one strategy that has proven itself throughout the years to have a great deal of validity when it comes to choosing the right stocks at the right time.

Since 1972, the Dogs of the Dow – a simple, yet powerful stock investment technique – has been used by investors to grow their portfolio wealth by strategizing to beat the overall Dow Jones Industrial Average index – and it frequently works very well.

What is the Dogs of the Dow Strategy?

The Dogs of the Dow investment strategy entails using an easy formula for selecting ten of the highest dividend yielding stocks from the Dow Jones Industrial Average, or DJIA, index at the beginning of each year.

The Dow Jones Industrial Average is a stock market index that consists of 30 of the most respected companies in the world. These stocks are typically large and mature, and are oftentimes considered to be good long term investments in and of themselves. For many years, investors have placed their funds in individual DJIA stocks in hopes of obtaining gains through dividends as well as via a rise in the price of the stock itself.

With stocks, the dividend yield is determined by dividing the annual dividend amount by the share price of the stock. A particular stock may have a high dividend yield due to a low share price based on overall market conditions or because of factors that are specifically related to that company.

The Dogs of the Dow technique was created in an attempt to beat the overall DJIA index, and the reasoning behind the strategy is that even though the ten “laggards” currently possess high dividend yields, they are still considered to be good investments – otherwise they would not be included in the Dow index. This is because historically, the companies that are included in the DJIA have always been stable companies consisting of strong fundamentals.

Theory states, then, that at least some of these ten companies – or “dogs” –  are likely to rebound, once the market has revalued them. At that time, the ten – or at least some of the ten – stocks that are the “dogs” can then be replaced with others that are considered to be the laggards at the beginning of the following year. So in essence, investors capture their gains when they sell their “dogs” that have regained favor in the market. They then repeat the process with the replacement “dog” stocks that are purchased the following year.

How to Select the Right Stocks

Selecting the stocks for the Dogs of the Dow strategy is relatively easy. Typically, after the stock market closes on the last day of the year, investors using this strategy will determine which ten of the Dow 30 stocks have the highest dividend yield.

For 2011, the ten top dividend yielding stocks in the DJIA include the following:

Company

Stock Symbol

Dividend Yield %

Forward P/E

AT&T

T

6.13%

11.30

Verizon

VZ

5.45%

16.10

Pfizer

PFE

4.39%

7.90

Merck

MRK

4.38%

9.10

Kraft Foods

KFT

3.69%

15.50

Johnson & Johnson

JNJ

3.43%

12.60

Intel Corp

INTC

3.38%

10.90

McDonald’s

MCD

3.36%

14.50

DuPont DeNemours

DD EI

3.32%

14.10

Chevron Corp

CVX

3.32%

14.10

Once the ten stocks have been determined, investors will ideally invest an equal amount of money in each of these companies. In this case, it is less important to have an equal number of shares in each stock as it is to have an equal dollar amount invested in each.

It is also not important whether or not investors own an even 100 shares – or “round lot” – of each stock. In the past, brokerages would penalize investors for purchasing “odd lots,” with higher commissions. However, today that is typically not the case.

Dogs of the Dow Alternatives

For investors who want to participate in the Dogs of the Dow strategy but may not have enough capital to put into ten stocks, there is still a way to invest using a variation of this technique. This strategy is sometimes referred to as the Puppies of the Dow.

Here, investors still determine the ten highest yielding Dow stocks on the last day of the year. However, using the Puppies strategy, the five companies with the lowest stock price are chosen to invest in – each with an equal dollar amount.

Does the Dogs of the Dow Strategy Really Work?

Like any popular technique, the Dogs of the Dow strategy has both its fans and its critics. Yet, over time, this particular strategy seems to have proven its validity. Between the years of 1973 and 1996, investors using this method saw returns of over 20 percent annually, while the Dow Jones Industrial Average overall returned just under 16 percent. But what about during the more recent market downturn of the past few years?

Although market fluctuations have caused many investors to lose money – and sleep – the Dogs of the Dow strategy has continued to provide gains to its proponents. In fact, in 2006, the Dogs technique surged upward with a gain of over 30 percent.

While 2007 ended with flat returns for Dogs of the Dow investors and 2008 saw a decline, a rebound in 2009 showed a gain of nearly 17 percent, while last year ended up over 20 percent ahead. Not bad in a market that is still filled with turmoil and uncertainty.

The Bottom Line

Although the Dogs of the Dow has proven itself throughout the years, it is not foolproof. Similar to any other investment strategy that involves risk, past performance does not guarantee future results. Likewise, it is never safe to assume that the same market conditions that have existed in the past will continue going forward. If, however, the market performs in a similar fashion in the future, the Dogs of the Dow strategy could offer roughly a 3 percent higher return than that of the DJIA index overall.

It is also important to keep in mind that this is not a “set it and forget it” technique. Each year, investors must determine which “dogs” need to be replaced with other stocks in the Dow 30 that have higher dividend yields. Therefore, some amount of monitoring and adjustment are required. That being said, for investors who are seeking simplicity coupled with proven results in a variety of market conditions, the Dogs of the Dow may very well be the way to go.

The Dogs Of The Dow

The Dogs of the Dow is an investment strategy popularized by Michael B. O’Higgins in 1991 in which an investor annually invests in the ten Dow Jones Industrial Average stocks whose dividend yield is the highest. “The Dogs of the Dow” is named because the stocks with the highest dividend yield are viewed as “dogs” that no one wants at that time.

The Dogs of the Dow strategy takes advantage of the fact that blue chip companies do not alter their dividend to reflect trading conditions in the stock market and, therefore, the dividend is a measure of the average worth of the company.  The stock price, in contrast, fluctuates through the business cycle. This should mean that companies with a high dividend yield, are near the bottom of their cycle and are more likely to see their stock price increase faster than low yield companies.

Under this model, an investor annually invests in high-yield companies that should out-perform the overall market. The investor is reward for waiting for the price to increase by a relatively high dividend yield.  The logic here is that the high dividend yield suggests that the stock is oversold and that management believes in the prospects of the company as demonstrated by a higher dividend.

Higgin’s used data mining to demonstrate The Dogs of the Dow theory.