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Education: Value Investing

Printable Version

"Dogs of the Dow"

The Dogs of the Dow is an investing strategy that was introduced to the world in 1991 by Michael O’Higgins in his book, “Beating the Dow.” The Dow, in Dogs of the Dow, refers to the Dow Jones Industrial Average—the oldest (developed way back in 1896 by Charles Dow) and most widely recognized index of U.S. stocks. But what exactly constitutes a Dog? Furthermore, how successful has this strategy been?

The Dogs Defined

In a nutshell, The Dogs of the Dow strategy involves the purchase of equal dollar amounts of the 10 Dow Jones Industrial stocks with the highest dividend yields. Then one is to hold these companies for exactly one year. When the year comes to an end, the portfolio is then adjusted to reflect the new stocks that the dogcatcher has rounded up.

Dividend yield is calculated by dividing a company’s dividend by its current stock price. The resulting high yielding stocks that make up the investment portfolio are the ones with prices that are low relative to the dividend paid. These may be stocks that are out of favor with the hope being that they will rebound in the next year, fail to make the portfolio (because their prices have hopefully risen, driving down their yield) and be replaced with a new litter of underpriced stocks. After all, companies that make up the Dow Jones Industrial Average are well-known, mature companies with strong balance sheets and financial strength, correct? Companies like this cannot stay undervalued for too long.

If you had $1,000 to invest, you would simply put $100 into each stock, hold them for one year and dump the companies that are not on the list one year later. Rinse and repeat the following year, and so on.

O’Higgins also goes on to present an alternative, called the Small Dogs of the Dow, for those who wish to purchase a smaller number of stocks. Those investors who fall into this category have the option of buying the five companies with the lowest stock prices from the original list of 10 Dogs—allocating 20% into each, or $200 when sticking with the example discussed above.

Performance for the Dogs?

So exactly how successful or unsuccessful has this strategy been over time? Do these Dogs really deliver a bite worthy of an investor’s time and money?

According to www.investopedia.com, from 1957 to 2003, the Dogs outperformed the Dow by about 3%, averaging an annual return of 14.3%, compared to 11% for the Dow. The performance between 1973 and 1996 was even more impressive, as the Dogs returned 20.3% annually, while the Dow produced a 15.8% return. The website www.dogsofthedow.com provides a plethora of data along with a table illustrating the performance of one, three, five, and ten year periods (assuming reinvestment of dividends).

Beware the Dogs?

Sure there are periods of time in which the strategy beats the overall market; however, can one exclusively rely on it year after year? We at Zacks would say it depends—primarily on the Zacks Rank of each of the stocks making up the portfolio. If all of the stocks upon purchase have either a Zacks Rank 1 (strong buy) or 2 (buy), then go for it. However, we may have some classified as a sell or a strong sell that you should steer clear of. Furthermore, throughout the annual holding period required by the strategy, events may cause the stock’s Zacks Rank to plummet. It would be foolish to hold on to companies of this nature.

 

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