An Investing Plan Gone to the Dogs

By: Dave Kansas, Wall Street Journal, 9 January 2011

Everyone is hunting for higher yields, but they're not so easy to find, especially in the fixed-income market. That has more people searching for dividends in the stock market.

One of the most venerable dividend plays in the stock market is the so-called Dogs of the Dow strategy. It is an investment plan focused on capturing the highest dividend payouts among the 30 blue-chip stocks in the Dow Jones Industrial Average, the oldest, most widely cited stock-market indicator in the world.

Some Dog players focus on the five-highest dividend yielders, other focus on the 10-highest dividend yielders, usually establishing the Dow Dog group at the start of each year. Building a standard Dog portfolio consists of buying an equal number of shares in each Dog stock.

The fundamental underpinning of Dog investing flows from the bedrock notion of annual portfolio rebalancing. Dividend yields -- which are just the annual dividend divided by the stock price -- tend to rise as stock prices decline. Therefore, picking the highest-yielding Dow stocks should put you among the stocks that lagged in the 30-stock blue-chip measure the year before. Rather than chasing winners, you are picking up the laggards -- the dog stocks -- hoping their fortunes will turn, which is usually a solid bet among blue chips.

This year's Dow 10: AT&T (yielding about 5.85%), Verizon Communications (5.46%), Pfizer (4.57%), Merck (4.22%), Kraft (3.68%), Johnson & Johnson (3.49%), Intel (3.42%), DuPont (3.29%), McDonald's (3.18%) and Chevron (3.16%).

A glance tells you a few things. One, telecommunications stocks are paying hearty yields, and some skeptics wonder how long that will last. Vodafone Group, which isn't among the Dow industrials, pays 4.87%, and Qwest Communications pays 4.2%. Also, drug stocks have struggled in recent years -- three are among the Dogs.

The Dogs, whether you choose five or 10, have a better dividend yield than the market. The Standard & Poor's 500-stock index has a dividend yield of 1.87%, down from 2.09% one year ago, mainly due to its 13% rise in 2010. The Dow industrials yield 2.46%, a reflection of the blue chips' willingness to raise and maintain dividends even as the average rose 11% last year.

The advantage of the Dog strategy is that you get paid a solid dividend yield and you have the added advantage of potential capital appreciation in share price.

The Dogs of the Dow is popular, but how successful has it been? In the last 10 years, the 10-stock Dow Dogs have beaten the Dow industrials on a total-return basis five times. The five-stock Dow Dogs have beat the average six times.

Over the past 20 years, the Dow Dogs 10 have recorded an annual average return of 11.62%; the Dow Dogs 5, 13.78%; and the Dow industrials, 11.61%.

Perhaps surprisingly, given its popularity, the Dogs strategy doesn't attract a great deal of mutual-fund interest. That's partly due to the simplicity of the strategy. It's easy enough for a lot of investors to build their own Dog portfolio without having to fork over management fees.

Happy hound hunting!