Dogs of the Dow

10/18/2018 5:00 am EST

Focus: STRATEGIES

Ned Piplovic

Assistant Editor, Eagle Financial Publications

The Dogs of the Dow strategy seeks to take advantage of investing in well-established, blue-chip companies with verifiable long-term returns on shareholders’ investments, explains income expert Ned Piplovic, editor of DividendInvestor.

The Dogs of the Dow strategy seeks to take advantage of investing in well-established, blue-chip companies with verifiable long-term returns on shareholders’ investments. In this case, the Dogs of the Dow targets the companies included in the Dow Jones Industrial Average (DJIA).

By design, the strategy is fairly simple to implement. After the last market closing at the end of the year, investors select the 10 Dow stocks with highest dividend yields and invest equal amount of funds into each of the 10 stocks on the first trading day of the following year.

A $10,000 Dogs of the Dow strategy would involve investing $1,000 into each of the 10 highest dividend yield stocks. At that point, the Dogs of the Dow strategy require no further attention until the end of the year when the process repeats every subsequent year.

In addition to replacing any stocks based on the highest dividend yields, investors must also rebalance the Dogs of the Dow to start each year with an equal amount of money invested in each of the 10 equities.

Because Dogs of the Dow is a long-term strategy, the repetition is a fundamental feature of the strategy. Investors should not expect to follow the strategy intermittently and have a high probability of long-term gains.

In some years, the Dogs of the Dow will outperform the overall Dow index. In other years, the Dogs of the Dow will underperform. However, the average gains over long time horizons provide the investors in this strategy the desired positive gains.

Executing this strategy is very simple and — while it must take place during the New Year holiday — it requires very little time and resources and leaves plenty of time for other work-related tasks at year end, as well as holiday festivities.

The basic concept behind the Dogs of the Dow is that the high dividend yields stem from share price declines. Therefore, due to the cyclical nature of the business cycle, the Dow stocks with the highest yields — depressed share price — are more likely to reverse trend and offer asset appreciation over the subsequent 12-month period.

Furthermore, many of the Dow companies have definitive dividend payout strategies and dividend payouts are generally far less volatile than share prices. Therefore, substantial share price declines will be main the drivers of significant dividend yield increases.

Strategy Variations

Always seeking to improve on existing strategies, investors have developed several variants of the Dogs of the Dow strategy. The Small Dogs of the Dow — or the Dow 5 — starts out as the original strategy by selecting the 10 Dow stocks with the highest yields.

However, the Small Dogs strategy calls for investing equal amounts in the five lowest-priced stocks among the 10 stocks with highest yields. Additionally, the Dow 4 strategy is identical to the Small Dogs strategy, except the final investment is in just the four lowest priced equities.

Motley Fool popularized a version of the strategy called the Foolish 4. The selection of the four equities for this strategy is the same as the Dow 4 strategy. The only difference is that the Foolish 4 strategy calls for allocating 40% of the investment funds into the lowest priced stock of the selected four stocks and split the remaining funds evenly among the other three picks — 20% each.

Historical Performance of the Dogs of the Dow Strategy

Historical performance back-testing indicates that the Dogs of the Dow strategy performed well over extended time horizons. The strategy either performed at least as well as the overall Dow Jones Index or better and generally outperformed the S&P 500 Index. However, it is important to underscore again that this strategy is not reliable over the short term.

Additionally, the Dogs of the Dow strategy struggled to adjust to any extraordinary market disruptions, such as the 2018 financial crisis or the dot-com boom. In both of those instances, the Dogs of the Dow strategy trailed the Dow Index and needed longer to recover.

Currently, the following 10 stocks would be the included in the strategy:

  1. Verizon Communications (VZ)
  2. IBM Corporation (IBM)
  3. Exxon Mobil (XOM)
  4. Chevron Corporation (CVX)
  5. Procter & Gamble (PG)
  6. Coca-Cola Co. (KO)
  7. Pfizer (PFE)
  8. Cisco Systems (CSCO)
  9. Merck (NMRK)
  10. Intel Corporation (INTC)

However, out of the top five companies listed by highest yield above, only Verizon would be included in the Small Dogs of the Dow strategy. This strategy would include:

  1. Pfizer
  2. Coca-Cola Co.
  3. Intel Corporation
  4. Cisco Systems
  5. Verizon Communications

Furthermore the Dow 4 strategy would eliminate Verizon and the Foolish 4 strategy would allocate the 40% to Pfizer as the stock with the lowest share price.

The Dogs of the Dow investment strategy is a simple and extremely fast way to identify large, well-established companies with high dividend yields that should have the best potential for share-price growth over the subsequent year.

As the information is readily available and easily accessible, investors need only few minutes to identify the stocks for the strategy and the time to set up 10 trades.

Another crucial ingredient for a success with this strategy is patience. Because this is a long-term strategy, investors must be disciplined and disregard short-term volatility to enjoy the expected gains over extended time horizons.

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