Dogs of the Dow Revisited

The “Dogs of the Dow” are the ten highest yielding stocks in the Dow Jones Industrial Average.  The reason they were referred to as “Dogs” is because stocks with unusually high dividend yields are often stocks whose prices have dropped, sometimes dramatically, because of bad news.

American companies, unlike their European counterparts, try to keep their dividends steady or increase them over time.  If they run into problems, including earnings declines, reducing the quarterly dividend is usually the last step.

To give an example, if a company whose stock which is priced at $100 per share pays a $2.50 dividend it is said to have a 2.5% yield.   If the company runs into problems and its share price drops to $50, the dividend yield is now 5.0%.  Thus it becomes a “Dog.”

Most companies run into problems from time to time: sales slow down and investors sell to invest in the next new thing.  That’s what happened to McDonalds a few years ago.  When oil prices dropped sharply so did the price of oil company stocks.  When natural resources prices dropped because of reduced demand so did the price of companies like Caterpillar which makes mining equipment.  Technology goes in and out of favor for various reasons and so does the price of tech stocks.

But most companies learn how to cope with adversity and make the appropriate changes to make a comeback.  That’s what often happens and it provides a way for investors to buy companies when they are cheap and make a profit.

The Dogs of the  Dow are a method of creating a portfolio of high yielding but out-of-favor stocks in the expectation that most will recover and provide a nice profit.

 So how have the “Dogs” done over the past 5 years?  We have tracked the performance of the “Dogs” using the share prices and yields of the 10 highest yielding DJIA stocks as of the last trading day of the previous year.  Here are the results:

• 2011          16.4%
• 2012          10.1%
• 2013          19.1%
• 2014         10.6%
• 2015           2.9%

These returns are “total returns” and include dividends but do not include fees or expenses.  It should also be noted to these returns are different if the starting point was not the value as of the end of the prior year and the ending point was different.  It should also be noted that a 10 stock portfolio is not properly diversified and I have simplified the process of buying, trading and balancing the “Dogs.”

As a final note, this strategy was popular in the 1990s and as it became more popular it became less effective.  In addition, as technology stocks gained popularity in the late 1990s, the “Dogs of the Dow” lost money as investors moved massively away from old-line DJIA stocks and into the tech sector.  As they say in the prospectuses, past performance is no guarantee of future results.

For more information, contact us.

Apple Joins the Dow

From the Wall Street Journal

 

Apple will join the Dow Jones Industrial Average this month, a long-anticipated change that adds the world’s most-valuable company to the 119-year-old blue-chip index.

The move is the latest milestone for Apple, which has emerged in recent years as the standard-bearer for a resurgent U.S. technology sector. The Cupertino, Calif., company in January reported latest-quarter net income of $18 billion, the largest quarterly profit on record, fueled by roaring sales of iPhones.

Apple will replace telecommunication giant AT&T, according to S&P Dow Jones Indices, the unit of McGraw Hill Financial Inc. that owns the Dow.

This will affect the Dog of The Dow since AT&T is currently the highest yielding DJIA stock.

How the “Dogs of the Dow” can make you money while getting you tax-advantaged income.

The “Dogs of the Dow” is an investment strategy that became popular in the early 1990s following a book written by Micheal O’Higgins.  The premise is simple: invest in stocks that are currently disliked or have underperformed (buy low) and wait for the economy, or management, to turn the situation around (sell high).  The problem for investors is determining how to identify the stocks that meet these criteria with the least risk and the possibility of making a profit.

The “Dogs” strategy starts with the 30 stocks in the Dow Jones Industrial Average (the “Dow” ).  To be part of the Dow a company has to have been around for quite a while, be an industry leader, and have stable finances.  Investing in these stocks means that the risk of investing in a real “loser” are low.

So which of these 30 stocks are under-loved?  The “Dogs” use dividend yield as a proxy for being underappreciated and undervalued.  At any one time, the “Dogs” are the top 10 highest yielding stocks in the Dow.

The final step is to invest an equal number of dollars in each of these ten stocks, hold them for a year, and repeat the process.  This usually means that after a year some of the stocks you own will no longer be among the top ten dividend payers, and each stock will no longer be one-tenth of your Dogs portfolio.  You sell those who are no longer in the top ten, replacing them with stocks that have become one of the top ten dividend payers, and re-balance the Dogs back to equal dollar amounts.

The “Dogs of the  Dow” strategy has been promoted as a way of beating the Dow, and in some years it has.  But that’s not necessarily the reason it may be appropriate for some investors, especially those who are looking for tax advantaged income.

Let’s look at the tax code.  The maximum rate of tax on qualified dividends is:

• 0% on any amount that otherwise would be taxed at a 10% or 15% rate.
• 15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%.
• 20% on any amount that otherwise would be taxed at a 39.6% rate.

In other words, “qualified” dividends (dividends paid by a U.S. corporation or a qualified foreign corporation)  are taxed like long-term capital gains, and at a lower rate than interest on CDs, corporate bonds and treasury bonds. At a time of ultra-low interest rates, getting a dividend of 3% to over 5% from a Blue Chip company may offer an attractive alternative to investing in bonds for those looking for current income.

In addition, of you sell a stock after holding it for a year and make a profit that is considered a long-term capital gain.  And long-term capital gains are also taxed at preferential rates.

There are some other requirements that affect the tax rate on qualified dividends and capital gains so consult your tax advisor about your particular situation.

The Dogs are not for everyone.  First, ten stocks are not considered a well-diversified portfolio and we at Korving & Company believe firmly in diversification.  Second, at some point the stock market will take another tumble and the Dogs will tumble along with the rest and we are also big practitioners of risk control.  Third, unlike CDs and high quality bonds, stocks never “mature” and pay you back your principal.  Investing in stocks exposes you to more risk that putting your money in the bank or purchasing short-term treasury bonds.  Before recommending that people invest in the Dogs, we carefully examine whether this is right for them.   Don’t buy the Dogs without getting professional advice.

However, at a time when many are anticipating that interest rates will go up, which means that bond prices will go down, people looking for income may want to consider if the Dogs are right for them.

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