The "dogs of the Dow" investment strategy sounds great in theory. It advocates buying the 10 highest-yielding stocks among the 30 industrials at the beginning of each year, holding them until the start of the next year and then beginning the process anew.
That way, an investor can presumably fatten his dividend returns, thereby building a substantial buffer against any market downturns while also acquiring solid blue-chip stocks that are cheap by virtue of being temporarily out of favor. The dogs' yields, of course, wouldn't be so fat if the stocks weren't so beaten down in value.
Mixed results
The strategy was promulgated by a money manager named Michael O'Higgins in his 1991 best-seller, "Beating the Dow," based on back-testing of the dogs' performance over several decades. And for a time in the mid-1990s, the strategy continued to work.But then came the tech bubble of 1997-99, during which the stodgy dogs of the Dow got smoked -- not only by the then-technology-heavy Standard & Poor's 500 Index ($INX) but also by the 30 stocks in the Dow Jones Industrial Average ($INDU).
And while the dogs provided some protection in the 2000-02 bear market against the slide in both the S&P 500 and the Dow, the strategy's performance has been mediocre since.
For example, in the baleful market downturn of 2008, the dogs did even worse, falling 38.8%, compared with a 37% decline in the S&P 500 and a 31.9% drop in the Dow. Moreover, the dogs badly trailed both indexes in the turnaround year of 2009, delivering a positive total return of just 17.8% compared with a 26.5% jump in the S&P and a 22.7% gain for the Dow 30.
This disappointing two-year skein was largely the result of dividend eliminations and the stock collapses of American International Group (AIG, news, msgs), Citigroup (C, news, msgs) and General Motors in 2008 and a flurry of dividend cuts in the 2009 dogs. So much for the supposed defensive and cheap-valuation advantages afforded by the dogs of the Dow.
As a result, the dogs have shown a compound annual return over the past 15 years (1995 through 2009) of 7.6%, compared with the S&P's 8.0% and the Dow's 9.2%.
Yet perhaps not all is lost for the strategy despite the dogs' difficulties in recent years. After all, during that decade and a half, they beat the S&P 500 in six years and tied it once, and outstripped the Dow seven times and tied it once.
Intriguing list for 2010
The good news for fans of the dogs of the Dow theory is that, with the economy seemingly on the mend, the hazard of dividend cuts and the collapse of once-venerable Dow names have receded somewhat.In addition, the roster of dogs for 2010 looks quite strong, even if some names -- say, General Electric (GE, news, msgs) and Pfizer (PFE, news, msgs) -- have struggled mightily and somewhat unsuccessfully to recover their former magic.
Telecoms Verizon (VZ, news, msgs) and AT&T (T, news, msgs) likewise appear to be deftly navigating the transition from land lines to mobile telephony and other digital delivery systems.
And then there's Kraft (KFT, news, msgs), now trying to take over Cadbury (CBY, news, msgs). The fact that Warren Buffett is a current 9% holder is an unimpeachable indication of Kraft's undervaluation.
Rounding out the portfolio is McDonald's (MCD, news, msgs), a pre-eminent global brand.
