October 11th, 2011
by Bill Barnhart, Y-Charts
For all the maladies in the 2011 stock market, one old friend seems to have been brought back to life. After three years in the dog house at the end of the last decade, the Dogs of the Dow investment strategy is on the mend.
The strategy is simple – at the beginning of the year, buy shares of the 10 highest yielding stocks in the 30-stock Dow Jones industrial average. Repeat the process each year. The concept is clear, especially if you don’t consider transaction costs. A contrarian investor looks for price bargains among historically strong companies; an income-oriented investor looks for yield.
Follow up:As long as short and long-term interest rates remain at record lows and the animal spirits of entrepreneurs remain subdued, collecting the attractive dividend yields of the Dow Dogs is smart investing. During the bear market of the mid-1970s, the Dogs enjoyed healthy gains. They did less well in the technology stock boom of the 1990s.
Consider, for example, the fairly tight correlation of the dividend yield of AT&T (T), a frequent Dog in recent years, and the nation’s unemployment rate.
For the three years 2007 through 2009, the Dogs of the Dow approach failed. A dollar invested in the 10 stocks selected in each of those years on average did less well than a dollar in an exchange traded fund reflecting the full DJIA (DIA). (The calculation does not include reinvested dividends,) But 2010 was a good year for the Dogs. Through three quarters, the 2011 Dogs are on average decisively beating the 5.7% drop in the DJIA. The dogs dropped on average 2%, ranging from a 14.5% advance by McDonald’s (MCD) to a 20% loss by DuPont (DD).
As of Dec. 31, 2010, the top dividend yield to buyers of AT&T, the leading Dog, was 5.9%. The smallest yield among the dogs as of the end of last year was 3.1% at General Electric (GE). The other 2011 dogs are Verizon Communications (VZ), Pfizer (PFE), Merck (MRK), Kraft Foods (KFT), Johnson & Johnson (JNJ) and Chevron (CVX). As of Sept. 30, nine of the 10 dogs would re-up for another year. McDonald’s share price rally this year would knock it off the list, to be replaced by financial services giant Travelers (TRV).
The Dogs of the Dow strategy rests on a forecast that certain of the Dow 30 stocks are in a temporary lull, based on operational issues and market sentiment. For example, reports of expiring drug patents wounded several major pharmaceutical stocks in 2010. The strategy depends on the troubles that depressed a stock’s price not resulting in a dividend cut.
An investment program that reconstitutes a 10-stock portfolio once a year will be hurt by transaction costs and taxes, to the extent price gains are realized by taxable investors. On the other hand, if you’re building a long-term portfolio, current market and economic conditions are ideal dog days to enter the stock market.
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