The Dogs of the Dow is an investment strategy popularized by Michael B. O'Higgins in 1991 and the official Dogs of the Dow website, which proposes that an investor annually select for investment the ten Dow Jones Industrial Average stocks whose dividend is the highest fraction of their price. Under other analysis these stocks would be considered "dogs", or undesirable, but the Dogs of the Dow strategy proposes these same stocks have the potential for substantial increases in stock price plus relatively high dividend payouts.
History
Selecting some components of the DJIA is not a new idea. An article by H. G. Schneider was published in The Journal of Finance in 1951, based on selecting stocks by their price–earnings ratio.
Concept
Proponents of the Dogs of the Dow strategy argue that the blue-chip companies that make up the Dow Jones Industrial Average are better able to withstand market and economic downturns and maintain their high dividend yield due to their access to credit markets, ability to hire top level management, ability to acquire dynamic companies, etc. Since a high yield often occurs after a significant stock price decline, a high dividend relative to stock price for a blue-chip company tends to suggest that the stock may be a reasonable value with the potential for the stock price to rebound in conjunction with a high dividend payout. Under this model, an investor annually reinvesting in high-yield, Dow companies has the potential to out-perform the overall market. The data from Dogs of the Dow suggests that this has been the case since the turn of the century. The logic behind this is that a high-dividend yield suggests both that the stock is oversold and that management believes in its company's prospects and is willing to back that up by paying out a relatively high dividend. Investors are thereby hoping to benefit from both above-average stock-price gains as well as a relatively high quarterly dividend. Due to the nature of the concept, the Dogs of the Dow will likely not cover all market sectors. For example, the ten stocks that belonged to the 2019 Dogs of the Dow list came from only seven sectors, including technology, energy, and healthcare, in contrast to the S&P 500 Index which covers eleven sectors.
Results
O'Higgins and others back-tested the strategy as far back as the 1920s and found that investing in the Dogs consistently outperformed the market as a whole. Since that time, the data shows that the Dogs of the Dow as well as the popular variant, the Small Dogs of the Dow, have performed well. For example, for the twenty years from 1992 to 2011, the Dogs of the Dow matched the average annual total return of the DJIA and outperformed the S&P 500. The Small Dogs of the Dow, which are the five lowest-priced Dogs of the Dow, outperformed both the Dow and S&P 500 with an average annual total return of 12.6 percent. When each individual year is reviewed, it is clear that both the Dogs of the Dow and Small Dogs of the Dow did not outperform each and every year. In fact, the Dogs of the Dow and Small Dogs of the Dow struggled to keep up with the Dow during latter stages of the dot-com boom as well as during the financial crisis. This suggests that an investor would be best served by viewing this as a longer-term strategy by giving this portfolio of stocks time to recover in case of a rare-but-extreme economic event.
Criticism
On January 8, 2014, John S. Tobey wrote an article in Forbes magazine where he criticized the Dogs. He said that it should use price weighting, instead of equal weighting, because that is what the DJIA uses. He said that, for the year 2013, using the price weighting the Dogs would have returned less, rather than more, than the DJIA. He suggested that it is too simple and it should use more factors such as dividend–payout ratio, growth of cash and earnings, price performance, and many other things. However, he did not say how to combine these into a strategy. He also criticized it for back-testing. He also said that the strategy would not work well for 2014.
