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Dogs of the Dow - A Mid-Year Check In

Author: James Brumley (info)
Website: http://bluegrassportfolio.com
Posted: May 23rd, 2007 at 3:36 pm EST
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Very early this year we took a break from our strictly-trading focus, and put the spotlight on the bluest of the blue-chips. Specifically, we decided to put the ‘Dogs of the Dow’ theory to the test, after seeing how well the strategy paid off in 2006 – the average dog gained 24.8% in 2006, versus the Dow’s overall gain of 16.3%.

In that same January 5th TrendWatch, we listed the Dow’s 2007 dogs. Though the year isn’t over yet, I thought it would be interesting to see if there were any evident benefits of using the theory so far this year. Of course, the final measure shouldn’t be taken until the end of December, but maybe we’ll dig up something trade-worthy with an interim look.

The Crash Course

For anybody new to the idea, here’s the quick and dirty explanation of the ‘Dogs of the Dow’ theory….it’s a value-based premise. The strategy ferrets out the ten most undervalued stocks among the thirty names that make up the Dow Jones Industrial Average.

The methodology is simple enough…find the ten stocks that have the highest dividend yield at a particular point in time among the thirty Dow Jones Industrial stocks. According to the strategy, at the end of the calendar year - or at the beginning of a new one - those ten high dividend stocks are bought to replace the Dow’s ten highest-dividend stocks from the previous year. The result is a ‘rolling’ ten stock portfolio.

The theory makes at least a little sense. Undervalued stocks are nice, particularly when they pay decent dividends. And, we like the simplicity of the strategy….you don’t have to be a brain surgeon to figure it out. Though the results of using the theory have been a little shaky in recent years, it’s still a logical approach.

However, the numbers say – at least for 2007 thus far – the theory still isn’t all it’s cracked up to be. The average ‘Dog’ is up 8.3% for the year, and I already mentioned the Dow is up 8.6%. That’s basically the same to us, but negates the purpose of bothering – you can just buy the index if that’s the best the theory does.

2007 Dogs of the Dow Returns, Year-to-Date

The theory is rubbish then? Well, no, I won’t go that far. Like we mentioned, last year it worked, and over the long haul it worked. A few months of backwards performance really shouldn’t unseat a reasonable premise.

Overall though, for longer-term positions, it’s not a bad strategy. However, I have to wonder if it’s a little incomplete. Maybe the right answer is to use the ten dogs as a starting point, and then weed out more of those names to narrow the list down to….say less than five. You can round out the rest of a long-term portfolio using names a little less off the radar. With that being said, I can’t say I’d blame you if some of you took this list – even at the mid-year point – and starting looking a little more closely at some of these names.

But wait, wouldn’t ten Dow stocks be about as diversified as you’d ever need to be? Honestly? No. I’ve seen these 30 stocks trade in a herd more than you might think. By venturing off the reservation and into small and mid caps, ETFs, options, and even ‘smaller’ large caps, odds are you may actually lower your overall volatility while simultaneously enhancing your bottom line.

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