‘Dow Dogs’ could be on the Cusp of 1990s-Style Resurgence by George McMiIllan for Lightspeed Trading
As both an investment strategy for retail investors and as a commission-making bonanza for brokers, the Dogs of the Dow strategy was a major winner back in the 1990s.
It all started in earnest with the book, Beating the Dow, by Michael O’Higgins, but the flames were fanned by a monthly newsletter entitled Dogs of the Dow.
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The book was bought literally by the dozen as brokers routinely handed them out to clients. Boxes of them littered the cube and offices of rookie and veteran producers alike. The newsletter was typically copied and handed out to the brokers as scripts for client phone calls.
But no matter how you found the strategy, both its execution and performance became very compelling for individuals and pros alike.
The strategy – although modified slightly from broker to broker – was to take the ten highest yielding Dow Jones Industrial Average stocks, and buy the five ‘cheapest’ of the group in equal weights. By ‘cheap’, the strategy dictated that you select the five stocks trading at the lowest current market prices. And if you were investing $100,000 in the strategy, you would buy whatever odd lots that added up to approximately $20,000 per position.
Here’s where discipline entered the picture – the strategy dictated you just sit back and wait. No matter what happened in the intervening twelve months, investors had to just hold those shares and let the dividends accumulate.
The holding period for the strategy was twelve months for good reason. After all,every Dow Industrial component stock was a high quality, blue chip holding. Bar none. So if you have purchased the five cheapest that are among the biggest yielders at the moment, the chances as those are out-of-favor gems that are surely due to appreciate once again.
That was the essence of the strategy.
After twelve months, when you reached your Dow Dogs ‘anniversary date’, you found out what the new five cheapest of the ten highest yielders are, sold the stocks that were no longer in the five, bought the new ones with the proceeds, AND reinvested all of the accumulated dividends you generated over the previous year in the new dogs. So you generated return from both share appreciation and dividend income – all of which got rolled back into your new dog five.
Simple, right? Probably too simple, but very, very marketable. Investors loved it. So did brokers. In fact, around 1997, there were small regional brokerage firms that had more than $50 million in client assets just devoted to the Dogs of the Dow. And if you couldn’t be bothered to manage the strategy yourself, you could simply buy a Unit Investment Trust which made it all automatic.
IMAGE: 1996 Dow Dogs Returned 22.8%
In 1996, the Dogs concept must have really resonated with investors as its performance – which on an absolute basis was great at 22.8% – actually trailed the DJIA’s return of 26%. That was the year in which the DJIA started the year at 5,117 and broke through the six-thousand barrier to finish the year at 6,448. Nevertheless, the strategy has given investors many years of exemplary performance.
Barron’s Advises Against Using Dow Strategy – Calls 2013’s 32.1% return ‘Luck’
Barron’s made waves in late 2013 when it came out against the dogs’ strategy. At the time they published their article on December 19, 2013, the strategy was up for the year 32.1% compared to the DJIA’s not insignificant 26.5% gain itself. And not only was the Dog strategy beating its benchmark, it was beating the broader market as well with the S&P 500 ‘only’ up 29.6% for the same period.
Despite this performance, Barron’s claimed that the strategy was no longer relevant because of the way companies have shifted their ways in which they return capital to shareholders. The once rare stock buyback is now being used with relative regularity. And while buybacks can boost share appreciation, they typically don’t add to investor returns as predictably or as regularly as dividend payments. Dividends, of course, have always been a critical backbone of the Dow Dog strategy.
While Barron’s made some great points, it seemed heavy handed to dismiss the strategy all together. That especially seems the case when you look at the return data below assembled by First Trust:
Dow® Target 5, 4th Qtr 2014 (Ticker: FWBOYX) is a unit investment trust that sticks closely to the Dow Dog strategy of buying the five lowest priced of the ten highest DJIA yielders. It differs most noticeably in one respect – First Trust holds the stocks for fifteen months rather than twelve. However, the trust’s long-term historical performance may prove that that small modification of the original strategy may be an advantage investors should consider.
Unit trusts like the one above require a $10,000 minimum investment. Of course, retails investors can always build their own Dogs of the Dow and manage it themselves for as many years as they like. Below are two scenarios – the first of which is an initial Dow Dog investment of $25,000 and the second is for an initial investment of as little as $5,000.
Regardless of the level of initial investment, retail investors are frequently tempted to deviate from the strategy which can lead to results far astray of what long-term investment in it have achieved. In the 1990s, it was fairly common for socially conscious retail investors to refuse to buy Dow-5 component Philip Morris because of its tobacco-industry focus. That’s no longer an issue since the company under its current name Altria Group is no longer in the DJIA. But some retail investors may refuse to own some of the DJIA’s oil companies or pharma names on personal grounds as well. If investors cannot blindly buy the stocks dictated by the strategy every year, perhaps it is the wrong strategy for them.
But for those investors who like an active management approach that emphasizes value investing in the premiere names in US equity markets, the Dow Dogs may still be highly relevant for them.
Lightspeed Trading offers retail investors interested in building a Dow Dog portfolio several low cost commission options that won’t unduly dampen investment returns. Find out about their low Stock and ETF commission rates at Lightspeed.com.
This article is provided for educational purposes only and is not considered to be a recommendation or endorsement of any trading strategy. The author is not affiliated with Lightspeed Trading and the content and perspective is solely attributed to the author.