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New
Dogs of the S&P 500
Remember the
Dogs of the Dow?
It was all the
rage back in the early 1990s, and for good reason. The stockpicking
strategy sported a convincing market-beating track record, yet only
required about an hour per year to pick the stocks. But it faltered when
the market turned red-hot in the late 1990s, causing investors to lose
interest.
It turns out
the Dogs strategy has performed about equal with the overall market in
recent years, but with much less risk. I’ll fill you in on the details
and describe a potential improved version in a minute. But first, some
background.
First
popularized by Michael O'Higgins in his 1991 book, “Beating the
Dow,” The Dogs strategy involves picking the 10 most out-of-favor stocks
in the Dow Jones Industrial Average, holding them for a year, and then
repeating the process. O'Higgins uses dividend yield (expected next 12
month’s dividends divided by the current share price) to pinpoint
out-of-favor stocks. Assuming the dividend doesn’t change, the yield
only increases when the share price drops. So O'Higgins defined the Dogs
as the 10 Dow stocks with the highest dividend yields.
Recent
Performance
Last week I
checked on the Dogs’ recent performance. The place to do that is,
naturally, the Dogs of the Dow website (www.dogsofthedow.com). The
site’s “Dog Years” page lists the strategy’s returns for the years
1999 – 2003, as well as its average annual returns for various periods
going back as far as 10-years. The site also lists the Dow and S&P 500
returns over the same periods.
At first look,
the Dog’s returns aren’t impressive. Considering only the average
annual returns, the Dogs are more or less even with the two major indexes.
But the data for the individual years tells a different story.
The Dogs’
returns were much less volatile than the indexes. For instance, in 2002,
the Dogs lost only 9% compared to the S&P 500’s 22%
loss and the Dow’s 15% drop. In 2000, a year both major indexes
lost ground, the Dogs gained 6%.
If you want to
follow the Dogs of the Dow strategy, you can start at any time by going to
the Dogs of the Dow site and clicking on Current Doggishness to see at
list of the current dogs. Simply buy equal dollar amounts of the 10 Dogs,
hold for a year, then sell and repeat the process.
Better Dogs?
In my view,
there’s room for improvement in the Dog’s strategy. For starters, the
Dow includes only 30 stocks. Of those, only 24 pay significant dividends
(1% or higher yields). That’s not much of a list to draw from.
Further,
dividend yields may not be the best way to identify out-of-favor stocks.
For instance, when I checked, Hewlett Packard’s share price had dropped
14% so far this year. That qualifies as out-of-favor in my book,
but the computer and printer maker’s 1.6% dividend yield only
ranked number 20, putting it far out of the running for Dog status.
In the interest
of improving the Dog’s bark, I devised a selection strategy I call the
S&P Dogs to overcome those shortcomings. Here’s how it works.
S&P Dogs
O’Higgins
used Dow stocks to limit the field to the biggest and strongest companies.
Selecting from these seasoned stalwarts reduced the odds of picking stocks
that might not survive the problems that sunk their share prices.
Instead of the
Dow requirement, I limit the selection to the largest companies in the
S&P 500 index. Why? For starters, only the leading companies in major
industries make it into the S&P 500.
Then, by
allowing only the largest players, I think I achieve O'Higgins’ goal
of picking firms with the resources to survive their current problems. In
this case, I define largest as companies with a minimum $10 billion market
capitalization. Roughly half of the S&P 500 stocks meet this
requirement.
Honoring the
spirit of O'Higgins’ concept, my S&P Dogs are simply the 10 stocks
on that list that have dropped the most in price over the past 12-months.
Screening is
the best way to find the S&P Dogs. MSN Money’s (moneycentral.msn.com) Deluxe Screener, and Reuters’
(www.investor.reuters.com) PowerScreener are the only Web screening
programs I know of that allow searching based on membership in the S&P
500. Start the process on one of those sites by setting up a screen with
the following parameters.
-
S&P 500
Index Membership: required
-
Market
Capitalization: greater than $10 billion
-
52-week price
change %: less than zero (negative returns only)
Here's a link
to the current results of that screen using MSN's Deluxe
Screener.
The 52-week
price change parameter isn’t necessary, but I added it so you can sort
the list with the worst performers (biggest losers) at the top. Do that
after your run the screen by clicking on the title (MSN) or sort button
(Reuters) at the top of the 52-week price change column. The 10 biggest
losers are the S&P Dogs.
When I ran it,
the list included March & McLennan, Merck, Applied Materials, Intel,
Charles Schwab, Clear Channel Communications, Texas Instruments, Analog
Devices, Fifth Third Bancorp and Washington Mutual.
To follow the
strategy, buy equal dollar values of each stock and hold the portfolio for
one-year.
While my
S&P Dogs strategy seems like a reasonable modification of
O’Higgins’ Dogs, I haven’t tested it over time. So don’t use real
money just yet. I’ll track its performance and advise you of the results
from time to time.
published 11/14/04 |
