The Dogs of the Dow Theory is an old friend and can be a comfort in stressful times. Does it work? Usually. On 31 December 2019, Barron’s reported the Dogs had “…beat the Dow Jones Industrial Average by more than one percentage point a year on average through the decade…[and] …earned almost 15% a year on average, better than the 13.4% return of the Dow and the 13.5% of the S&P 500…” [1]

The theory of Dogs of the Dow is simple which probably accounts for its popularity. A useful point to remember is the Dow Jones publishes three indexes: Industrial, Transportation, and Utilities. There are market strategists who use a concept known as the Dow Theory to predict the future of the market. The Dow Theory postulates that the relationship between the three indexes can have various meanings. Investment professionals spend a lot of time arguing about these concepts.

We are not writing about the Dow Theory. In Dogs of the Dow, only common stocks in the Industrial average are used. When you invest following this concept, you are using a large-cap value strategy. The theory works like this: on 31 December, you purchase the ten highest dividend-yielding stocks out of the thirty stocks, which comprise the Dow Jones Industrial Average. You rebalance precisely one year later, on 31 December, or as close as you can get, by holding the stocks you purchased one year ago that moved out of the bottom ten. Then, you buy the new stocks which have fallen into the bottom ten. You want to put equal amounts of money in every stock, including those you are already holding.  

The performance numbers used are all pre-tax. If you decide to pursue this strategy with a portion of your equity assets, I recommend purchasing these stocks in a tax-advantaged account. If you hold the stocks in a taxable account, you will pay taxes on the dividends and not get the returns that are typically cited.

Who came up with this theory? While victory has a thousand fathers and defeat is an orphan, the concept of Dogs of the Dow is most often attributed to the money manager Michael O’Higgins. He explained the theory in his book, Beating the Dow, which was published in 1991. [2] Here is his website: www.ohiggins.com [3]

There is another website solely devoted to the Dogs of the Dow theory, which contains a lot of free information on the concept, which you can find here: www.dogsofthedow.com/

On Wall Street, something worth doing is always worth overdoing. Hence, there are different ways to pursue this strategy using different methods. In the Small Dogs of the Dow, you purchase the five lowest-priced stocks of the thirty, which comprise the Industrial average. While the Small Dogs can be more volatile, the yield is often higher.

According to calculations performed by Barron’s, “The average dividend yield over the decade is almost 20%. Most of the return comes from dividends.” [4] Dogs of the Dow is a sound theory, and while it doesn’t work all the time, at least you have a portfolio of blue-chip stocks.

It also has a basis in fact, as opposed to cherished theories said to predict a bear market including if the same horse wins all three races in the Triple Crown, there will be a bear market, and if the New York Mets win the world series, there will also be a bear market. [5]  

 

Resources:

[1] https://www.barrons.com/articles/dogs-of-the-dow-stock-picking-strategy-was-a-winner-for-decade-51577795700

[2] https://www.harpercollins.com/products/beating-the-dow-

[3] Cannon does not recommend or endorse any financial services firm or products

[4] https://www.barrons.com/articles/small-dogs-offer-incredible-dividend-yields-51579611601                       

[5] https://www.snopes.com/fact-check/super-bowl-indicator/

 

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Contributing Writer: Subject Matter Expert Charles McCain