The Dogs of the Dow is an investment strategy devised by Michael O’Higgins in 2000, when he published Beating the Dow. The strategy has been both praised and criticized for its effectiveness to beat the market. The general idea behind the strategy is to invest in high-yield dividend stocks that have little risk. Mr. O’Higgins suggested that the best companies that produce the highest-yielding dividends with the least amount of risk can be found in the lower 1/3 of the Dow Jones Industrial Average (DJIA). The term “dog” refers to the stocks from the lower 1/3 of the DJIA. According to the old saying, “every dog has its day,” and so will the stocks added annually to the Dogs of the Dow. To implement this strategy, an investor will purchase the highest-yielding stocks in the DJIA at the start of each year and sell them at the end of the year in December.
Each year stocks listed in the DJIA shift position as the companies ebb and flow with the market and their business cycle. Companies listed in the DJIA are handpicked by the editors at the Wall Street Journal, who have diligently researched companies on the New York Stock Exchange and NASDAQ. Picking from the lower 1/3 of the DJIA typically produces high-dividend-yielding companies that are in a low swing of their business cycle. Buying stock in a company during its down cycle allows the investor to participate in the appreciation of the share price in addition to receiving dividends at a higher yield than companies in the upper 1/3 of the DJIA. In essence, the investor is rewarded twice for finding value in a company that is in its down cycle.
The logic behind the Dogs of the Dow strategy makes sense, but does it work? Can an investor really beat the DJIA or the S&P 500 year over year? According to Barron’s, the strategy worked consistently from 1973 to 2011. But 2011 was the first year in which the Dogs of the Dow underperformed other indices. The idea of the Dogs of the Dow follows the principles of value investing. Value investors look for companies that are undervalued by the market and believe the stock price does not reflect the true value of a company. Investors tend to be exuberant over good news and pessimistic about bad news. Pessimism caused by bad news leads the market to oversell a stock, allowing for a value investor to capitalize on the sell-off. The Dogs of the Dow strategy uses the dividend yield to pick the stocks with the best value in the Dow Jones Industrial Average. Similar strategies can be applied to the S&P 500 or other indicators of an oversold stock such as price-earnings ratio (P/E) and institutional ownership.