The coming year marks the 20th anniversary of the first use of "
Dogs of the Dow
" as an investment strategy, which focuses on the 10
highest-yielding stocks in theDow Jones Industrial Average (DJIA) .
In theory, these high yielders have been oversold (as the share
price falls, thedividend yield goes up) and are most likely to
outperform the rest of the Dow stocks in the next 12 months.
In its first decade, the Dogs of the Dow approach yielded
impressive returns from 1991 through 1996, though it couldn't keep
up with the scorching results posted by the major indexes in the
late 1990sbull market . In the first half of the last decade,
though, the Dogs of the Dow approach proved its mettle: By the end
of 2004, $1,000 invested using this theory would have returned +24%
while the broader S&P 500 and DJIA were roughly flat. Yet in
the next five years, the indexes caught up (or said another way,
the Dow Dogs portfolio fell back in line with all other
underperforming stocks in the 2008 market downdraft).
The Dow Dogs vs. the indexes since the end of 1999 (total
The key takeaway in the last 15 years is that this approach works
well in an era of slow growth and weak market returns, but doesn't
fare as well in an era of higher economic growth and more robust
market returns. So if you expect the U.S.economy to post lackluster
results in the next few years, which I suspect it may, you might
want to give the Dogs of the Dow a fresh look.
Buy the basket or cherry pick?
The above-cited performance results were generated by a passive
investment strategy that holds all 10 Dow Dogs. You could also look
to try and cherry pick the stocks that you think have the greatest
chance forcapital appreciation . For example,
offer very juicy dividends, but organic growth at each of these
companies is quite anemic and it's hard to see how investors will
suddenly find these stocks to be more appealing.
The remaining Dow Dogs appear to offer better paths to
would both clearly benefit from rising global economic activity
that pushes up demand for energy and industrial chemicals. And
Johnson & Johnson (NYSE: JNJ
Procter & Gamble (PG)
all would benefit from continued development of emerging market
economies, especially if the dollar eventually resumes its secular
Yet it is
that may be the most compelling name in the group, thanks to a
radical re-jiggering of its product lineup that should unlock
shareholder value. Kraft has been selling some units while
acquiring others, most notably confectionary firm Cadbury, which
was acquired at the start of 2010. The net result is that Kraft's
current range of products have much more resonance with consumers
compared to a few years ago, which allows management to more easily
push through price increases if necessary.
Kraft, which has more than 50 distinct brands with at least $100
billion in sales (11 of the brands, such as Nabisco, Oscar Meyer
and Maxwell House, have more than $1 billion in sales). The firm
now derives roughly 50% of its revenue from abroad and 25%
fromemerging markets . And since Kraft's product lines are more
likely to be segment leaders these days, management doesn't need to
play defense as much in terms of promotional activity. "We continue
to see Kraft as a much improved company. Results are coming in more
consistently and the forward outlook is strong," note the analysts
at Citigroup, who predictshares will rise from a current $30 to
Analysts at UBS are similarly bullish, predicting that 2011 results
will be characterized by emerging market growth, nearly $1 billion
in cumulative cost cuts at Cadbury, and steady price increases in
North America. In the next few years Kraft is expected to find
additional ways to get better results from promotional spending,
shed the lowest-margin divisions and eventually use thatcash flow
to boost itsdividend yet higher.
Action to Take -->
The Dogs of the Dow approach hasn't been discussed much in recent
years, but it worked quite well in the first half of the last
decade when the U.S.
was mired in a low-growth slump. But 2011 looks like a repeat of
the period from 2001 through 2003, so the time may be ripe again
for you to consider this strategy.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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