Sometimes, the best stock-picking strategies are the simplest
ones. The "Dogs of the Dow " theory is certainly simple
enough, yet amazingly, this aging strategy still has some proven
merit.
What it is
The Dogs of the Dow theory is now 20 years old, though is still as
relevant today as it was when Michael O'Higgins unveiled it in
1991.
His approach simply calls for investors to own the 10
highest-yieldingstocks among the Dow Jones Industrial Average's 30
constituents, as they are historically the most likely to
outperform theindex as a group.
While in practice, this approach can be applied any time of the
year. But the majority of the time, investors begin to wade into
those 10 positions at the end of the year, and/or the beginning of
a new year, with plans to hold those picks for the entire 12-month
period. And given the calendar, now is the appropriate time to
point out the Dow's 10 highest-yielding stocks. Take a look at the
table below...
Potential Pitfalls
Before anyone rushes out to buy these high-yielding stocks solely
based on someone's theory, a reality check may be in order for a
couple of reasons.
First and foremost, the strategy implicitly assumes that all 30
of the Dow's constituents value income distribution over
growth.
The reality is that some of the Dow's companies have established
themselves as dividend-oriented stocks because that's what
themarket is demanding.
McDonald's (
MCD
)
,
AT&T (
T
)
, and
DuPont De Nemours (
DD
)
are three heavily-traded stocks that come to mind because they
produce income. To expect any of them to outpace the Dow's average
return may be an unfair expectation.
A second reason the Dogs of the Dow strategy isn't bulletproof:
Some of these stocks are on the Dogs of the Dow list because the
only way they would have beaten the Dow would have been if they
significantly pumped up theirdividend rate.
If they had made forward progress in terms of price, then they'd
be off the list. In fact, seven of 2012's "dogs" were on the list
in 2010. Eight of 2013's Dogs of the Dow were on the list last
year.
Numbers Don't Lie
Still, while the past couple of years may not have yielded much
fruit for fans of the approach, over the long haul, there's
something to it.
In the past 20 years, the Dogs of the Dow approach has produced
an average annual return of 10.8%, versus an average annual return
of only 9.6% for the S&P 500. That's not bad, but don't get too
excited yet.
See, for the same 20 years, the Dow's average annual return was
also 10.8%, meaning the theory did no better or worse than owning
all 30 Dow stocks. However, for the past 10-year, five-year and
three-year periods, the Dogs of the Dow approach has produced a
better average return than the Dow Jones Industrial
Average.
Moreover -- and somewhat contrary to the notion that the dogs
must work their way off the list for the strategy to work -- in
2010 and 2011, the Dogs of the Dow basket did manage to outperform
the Dow even though most of those stocks had been on the list for
several years. How? It was indeed a combination of rising dividends
and a handful of Dogs that performed amazingly well.
Risks to Consider:
Though the theory works more often than not,bear in mind that
the Dogs of the Dow theory is deemed to be successful in any given
year as long is it outperforms thebenchmark . This means even if
Dogs collectively lose ground in any given year, as long as it
loses less than the Dow Jones Industrial Average, then it's still
scored as a win for the approach. It's still a loss, however, for
portfolios.
Action to Take -->
While it may not make sense to fill out an entire portfolio with
the Dogs of the Dow, it's an easy and effective way to place some
keyblue chips in your portfolio. And, although theupside of doing
so hasn't been bulletproof, the idea still been a better than
average one. Investors who used the Dogs of the Dow approach nearly
doubled the Dow's overall return in 2011, and have topped the
S&P 500's average annual return by more than one full
percentage point over the course of the past 20 years. That may not
be a huge difference, but those nickels and dimes add up over
time.