Harry Domash's Winning Investing


Dogs of the Dow

Use dividend yield to select out of favor stocks

Dogs of the Dow is a contrarian strategy that picks the ten most out of favor stocks, based on stock dividend yield, in the Dow Jones Industrial Average. You hold these high-yield Dow dogs for a year and then repeat the process by selecting ten new dogs. 

The strategy was first popularized by Michael O’ Higgins in his book, "Beating the Dow," published in 1991. O’Higgins showed that over the 17-year period from 1973 to 1989, his Dogs strategy averaged a return of 17.9% annually, compared to 11.1% for the Dow.

The Dogs of the Dow caught on with the investing public, and several brokerage houses offer vehicles for following the strategy.

Pick Your Own Dogs
You can select your own Dogs portfolio in minutes using the Internet. All the information you need is on (where else?) the Dogs of the Dow website (www.dogsofthedow.com). Everything on the site is free, and you don’t even have to register.

Traditionally, Dogs’ portfolios are selected on January first of each year. However, there is no reason to wait for the new year, you can start your portfolio anytime. In fact, since the strategy is so popular, it’s probably better to purchase the stocks ahead of that date.

When you get to the Dogs of the Dow home page, click on Current Doggishness to see a list of the current Dogs (based on last Friday’s close). This is the list to use if you want to start investing in the Dogs today.

Dividend Yield Pinpoints Dogs
The list includes Friday’s closing price and the dividend yield for each of the 10 Dogs. Dividend yield, the annual dividend divided by the stock price, is the metric used to determine the ten most beaten-down stocks. Stocks usually have high dividend yields compared to other Dow stocks because the company is out of favor and their stock price is depressed.

Pick Your Dogs
To follow the Dogs of the Dow strategy, simply apportion ten percent of your total investment to each stock. Don’t worry about buying less than 100 shares, most stockbrokers no longer penalize you for buying "odd lots." However, the commissions could hurt your results if you buy too few shares. Since you can’t buy fractions of shares, you will end up with slightly uneven dollar amounts invested in each stock. Hold these stocks for one year, sell the stocks that are not on the new list, and repeat the procedure.

If you don’t want to buy ten stocks, O’Higgins came up with another approach called the Small Dogs of the Dow, requiring the purchase of only five stocks. You select the five companies with the lowest stock prices from the list of 10 Dogs. It’s easy to pick them out because the Current Doggishness list includes a column titled "Small Dogs." The small dogs are the five stocks with a "yes" in this column.

To invest in the Small Dogs, follow the same procedure as for the 10 Dogs, except allocate twenty percent of your total investment to each stock.

Foolish Dogs
The folks at Motley Fool (www.fool.com) came up with a number of variations of O’Higgins’ strategies. The first, developed by Robert Sheard, named the Foolish Four, calls for the purchase of only four stocks. Sheard puts the lists of ten Dogs, and of the Small Dogs side by side. The Small Dogs list is sorted according to stock price, with the lowest priced stock at the top. He compares the two lists. If the same stock is at the top of both lists, he bypasses it and selects the remaining four Small Dogs. Otherwise he takes the top four stocks from the Small Dogs list. According to Sheard, this step reduces the chance of picking a stock that is cheap for good reason. Buy equal dollar amounts of the four stocks and hold for one year.

Sheard features the strategy in his book, "The Unemotional Investor." There he calls it the "Unemotional Value 4." Sheard’s research shows his selection strategy historically outperformed O’Higgens’ methods. My own experience bears this out.

It’s Dog Eat Dog
The Dog strategies have come under fire in recent years. Critics say they are based on picking out correlations, that by chance, worked in the past, much like using Super Bowl winners or hemline lengths to predict stock market performance. Others point out that even successful strategies stop working when they get too popular.

Recent Results: in the Doghouse
The last time the Dogs outperformed the overall market was in 1996 when the S&P 500 Index returned about 23 percent compared to 29 percent for the 10 Dogs, 26 percent for the Small Dogs, and 30 percent for the Foolish Four.

In 1997 the 10 Dogs, Small Dogs, and Foolish Four with returns of 22 percent, 21 percent, and 24 percent, under-performed the S&P 500’s 33 percent return.

In ’98 the 10 Dogs, Small Dogs, and Foolish Four fell far short of the market with returns of 11 percent, 12 percent, and 13 percent compared to 29 percent for the S&P 500.

As of July 15th of this year, the three variations of the Dogs all returned about 15 percent, just slightly ahead of the S&P 500’s 14 percent.

Dogs Will Have Their Day
The Dogs recent lackluster performance is understandable. The Dogs of the Dow is a value approach. The market’s recent strong performance is a growth stock story. Most value portfolios have been left in the dust.

History tells us the market goes through cycles—sometimes favoring growth stocks, other times favoring value strategies. Eventually, these dogs will have their day.
Published 7/19/99


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