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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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