Dogs That Make Your Tail Wag: Why Investors Should Use the Dogs of the Dow Strategy

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David Evanson and Oliver Pursche

Minyanville.com, Summer, 2012

The Dogs of the Dow strategy — investing in the 10 highest yielding stocks of the Dow Jones Industrial Average (^DJI) at the beginning of the year and then holding the shares until year-end — has been around for several decades.

The thinking behind the strategy is that the high yields are attributable to, among other things, lower stock prices. With a “reversion to the mean” theoretical framework, the Dogs strategy posits that these low, low stock prices will ultimately correct.

Over the past 20 years, the Dogs of the Dow has bested the S&P 500 (^GSPC) 1.2% on a compound annual basis (i.e., 9.6% vs. 10.8%). In 2011, the Dogs trounced the S&P by nearly eight-fold, according to DogsoftheDow.com. But as with so many “easy” strategies, a closer look and perhaps some fine-tuning can make a significant difference in performance.

In a market and economic environment where revenues are harder and harder to come by, and companies — in particular, multi-national companies — face a global demand slow-down, I believe balance sheet strength and earnings predictability are key to investor success and avoiding big mishaps. The current Dogs list has some real bright spots.

Take AT&T (T), for instance: The company will pay its investors a 4.71% dividend yield ($1.76 per share), has met or beat analysts’ earnings forecast every quarter since 2009, and is trading at a discount to most of its peers in the telecommunication sector.

Home Depot (HD), which can hardly be called a Dog anymore, boasts a 2.2% dividend yield. The company reported Q2 earnings this morning that beat analyst expectations and it raised revenue and EPS guidance for the remainder of the year. My firm bought shares of this home improvement company earlier this year as we saw revenues growing sharply ahead of expectations.

Lastly, Pfizer (PFE), which boasts a solid 3.71% dividend and has a strong history of raising its dividend, is planning to sell 20% of its animal health division (which will be called Zoetis) via an IPO. Analysts at Credit Suisse expect the sale to generate as much as $18 billion for Pfizer. The company has stated that it intends to use the cash to repurchase shares. Historically, companies that have consistently raised their dividends and repurchased shares have been among top performers within the S&P 500.