09) Stock Picking Strategies: Dogs of The Dow

by · October 16, 2010

The Dogs of The Dow are 10 of the 30 companies in the Dow Jones Industrial Average (DJIA) that has the highest yield in dividends.  This form of strategy was popularized by Michael Higgins’ book “Beating the Dow”. People like this strategy for its simplicity.  Basically, people work their portfolio around these ten companies so that it is always equally allocated to these ten.

That Simple?

Yes.   Investors who follow this strategy reassess the companies in the DJIA every year.  Once the highest yielding companies in terms of dividends are identified, your broker can make changes in your portfolio in accordance to the DJIA list.  You then hold on to these stocks for a year and then repeat the process at the end of the calendar year.  Usually, there will be two or three companies that are dropped from the DJIA so your portfolio will need to be realigned to the 10 stocks.

There have been instances where the Dow has beaten the Dogs, so this is usually a long term investment strategy.

The Premise

In theory, out of favor stocks from the DJIA are still good investments because once the market rebounds, these stocks can be revalued and resold and you can replenish them with other companies that have fallen out of favor.  Companies that make the DJIA are usually solid companies that have solid balance sheets.  They are known to be stable despite market decline.  Because the Dow is known for people who really know what they are doing, you can rest assured that the DJIA list is made up of good strong companies.

The Numbers

The strong point of the Dog of the Dow strategy is its simplicity.  Over the years, the Dogs have outperformed the Dow by an average of 3%.  From 1957-2003 The average rate of return for the Dogs as at 14.3% annually compared to the Dow’s 11%.  During 1973-1996 the Dogs gave returned 20.3% to investors annually while the Dow averaged a measly 15.8%.

Variations

Because it is simple, several clones of the Dogs of the Dow have been formulated.  A variation called Dow 5 includes the 5 Dogs with the lowest per share price.  Dow 4 is the 4 highest price of the Dow 5.  And then there’s the Foolish 4 wherein you choose the same stocks as the Dow 4 but allocates 40% to the lowest priced of these 4 companies and 20% to the three other stocks.  All of these variations aim to refine it, to make it simpler and to make it yield higher results.

These variations were developed from old data or back-testing.  There is no way of knowing that the Dogs will outperform the Dow every year.

Before you go out and apply these strategies, remember that while picking high yielding stocks makes sense, picking strictly on price is odd.  Share price is relative and a company can split its shares and still be worth the same amount.  They will simply have twice as many shares as before with half the share price.  With this kind of strategy, there are more questions rather than answers.

Not Certain

Remember that this strategy, is not 100% fool-proof.  It assumes that the same circumstance that happened during the mid 20th century will repeat itself during the 21st.  If this is true, then the Dogs will give investors an average of 3% return compared to the Dow.  But again, this is not guaranteed.

Conclusion

The Dogs of the Dow strategy is very simple.  You pick the top 10 highest yielding stocks off the top 30 list of the DJIA and weigh your portfolio equally among them.  Adjust your portfolio annually and expect a 3% rate of return per year should the Dogs outperform the Dow.  This is if history repeats itself.

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