Dogs of the Dow

Posted on October 19, 2012 | Financial Planning

Every January, Dogs of the Dow draws attention. The strategy is simple. At the start of every calendar year, sort through the 30 stocks in the Dow Jones Industrial Average and buy the 10 with the highest yields. An equal dollar amount is allocated to every stock and the portfolio is held for the entire year. On the first trading day of the next calendar year, repeat the process.

The idea behind the strategy is that every year a new portfolio will be created. This portfolio is designed to be held for 12 months. Investors should profit by purchasing supposedly out-of-favor stocks whose relative yields suggest their valuations are attractive.

The idea of buying the 10 highest-yielding Dow components was popularized by Michael O’Higgins and John Downes in “Beating the Dow” (Harper), first published in 1990. In the 2000 edition, the authors also discussed implementing the strategy at different times, such as in October or mid-December.

In actuality, there may be no benefit to buying stocks on the first day trading day of the New Year as opposed to, say, the day after Thanksgiving. While studies have shown that the markets tend to perform better between November and April than between May and October, last year “selling in May and going away” would have caused you to miss out on a rally that sent the Dow higher by more than 18%.

Yield is the amount of dividends paid relative to a stock’s price. The calculation is simple: total dividends expected to be paid over the next 12 months divided by current share price. For example, let’s say a company has historically paid a quarterly dividend of 25 cents per share and is expected to continue to do in the future. If the company’s stock trades at $40 per share, the yield would be 2.5%. (Total expected dividends of $1 per share divided by a $40 share price equals 2.5%.)

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