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The
Dogs of the Dow
Investment Strategy

 

How to use dividend yield to select out of favor stocks

 

Dogs of the Dow is a contrarian investment strategy that selects from the Dow Jones Industrial Average the ten most out of favor stocks, based on stock dividend yield. 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 of the Dow 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 now offer vehicles for engaging the strategy.

 

Dividend Yield Pinpoints Dogs
Dividend yield, the annual dividend divided by the stock price, is the method 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 thus, their stock price is depressed. The idea is that these Dow stocks are strong enough to eventually come back into favor and thus, bounce back.

 

Pick Your Dogs
To follow the Dogs of the Dow strategy, simply allocate 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 do not want to go to all that “work”, many brokerage firms offer prepackaged Dogs of the Dow investment products in the form of Unit Investment Trusts (these UITs are sometimes called “Select-10”, depending on your broker). For smaller amounts of money these are sometimes not only more convenient, but can also be more economical when it comes to figuring in commissions for these trades. For example, if your broker charges $7 a trade and you have to buy 10 stocks, that’s $70 in commissions you will pay. If it costs 2.5% to buy the UIT and you have only $2000 then the UIT is cheaper ($50). If you have $4000, buying the individual stocks for $7 is cheaper. You will have to determine which is best for you in your particular situation.

 

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.

 

Dogs Will Have Their Day
The Dogs of the Dow is a value approach. During periods of strong market performance when growth stocks are in favor, value portfolios can be left in the dust. History tells us the market goes through cycles—sometimes favoring growth stocks, other times favoring value strategies. Eventually, every dog has its day.

 

 

 

 

 

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