The Power of the Dogs of the Dow Strategy
Like metallurgists of antiquity who sought a method for turning base metals into gold, stock market investors are constantly on the hunt for a formula or a guide that reliably produces positive investment returns and gives them an edge on the overall market. The principle of Occam’s razor suggests that solutions involving fewer variables are preferable to those that require more inputs. Simpler is better because getting the job done with just a few moving parts carries less risk of confusion and failure than a highly complex system.
If reliability and simplicity are what you seek in stock market investing, it’s hard to beat the Dogs of the Dow. The investment strategy calls for buying equal dollar amounts of each of the 10 stocks in the Dow Jones Industrial Average with the highest dividend yields as a new year begins. After holding these stocks for 12 months, you rebalance the portfolio into the 10 stocks with the highest dividend yields one year hence and repeat the process annually. The idea is to catch high-quality companies while they’re temporarily down on their luck and bargain-priced, and to get paid by the dividends while you wait for the eventual recovery.
“I like to buy things that are cheap and the stocks that I buy are having problems, they’re in trouble, but do you really want to buy them when they’re not in trouble, when the price is abnormally high?” says Michael O’Higgins, the Miami-based money manager who promulgated the strategy 33 years ago in his book, Beating The Dow.
## The Historical Performance of the Dogs of the Dow
The Dogs of the Dow strategy has proven its mettle but experienced some cyclicality of its own. It underperforms the broader stock market during raging bull markets like we had last year, and in 1999 when the dot-com bubble inflated to untenable proportions. The dogs tend to outperform during bearish times like in 2022, and during major bear markets like those in 1972-1974 and 2000-2002.
Loaded up with big banks like Citigroup, Bank of America, and JPMorgan Chase that were on the verge of going belly-up before the feds came to the rescue, as well as the moribund General Electric, the Dow dogs lagged the broader market during the 2007-2009 bear market but rode a seven-year streak of beating the Dow from 2010 until 2016 as bank dividends suspended during the financial crisis were reinstated and financial stocks experienced a renaissance. More recently, the 10 Dow dogs have outperformed the Dow only twice in the past seven years as rock-bottom interest rates spurred a massive run in growth stocks, particularly in the technology sector with companies like Apple and Microsoft. With bond yields far above levels of two and three years ago, however, the tailwind for tech may prove fleeting.
“There are cycles and fashions in the investment world that go back and forth, and what tends to be working tends to continue to work for a while until it gets too far,” says O’Higgins, whose firm manages $160 million in assets.
## The Advantage of Dividend Yields in Value Investing
For more than half a century, the Dogs of the Dow has presented a compelling case that using dividend yield to gauge value among blue-chip stocks is a strategy of superior breeding for long-term success. With annual rebalancing and dividends reinvested through December 31, 2023, the Dogs of the Dow produced a cumulative total return since 1972 of 45,340%—more than double the Dow Jones Industrial Average’s 21,459% cumulative return, and 20,254% for the S&P 500 over the same stretch of time.
A five-stock subset has performed even better. The “Small Dogs of the Dow” are the five lowest price stocks among the full pack of 10. Since 1972, the Small Dogs produced an 81,752% cumulative total return, or 13.77% annualized through the end of 2023. That compares to 12.49% annualized for the Dogs of the Dow, 10.89% for the Dow 30 and 10.76% for the S&P 500.
“Low dollar-price stocks are more volatile, and since you’re buying stocks that are depressed in price and compressed in value, it’s like a spring, you push it down, and if you push it down further, it’s going to spring up more,” says O’Higgins. “A quarter-point move on a $10 stock is a lot more than it is on a $100 stock, so if you’re going to be outperforming, you’re going to outperform more with low dollar-size stocks.”
## The 2024 Dogs of the Dow: High Dividends and Billionaire Investors
With an average dividend yield of 4.2% as of January 11, 2024, the Dogs of the Dow produces 133% more investment income on an annual basis than the Dow Jones Industrial Average, and 186% more than the S&P 500 Index. The dogs offer you exposure to seven of the market’s 11 sectors, and with an average P/E of 14.7, they trade well below the 21.6 P/E ratio of the S&P 500 and the 26.7 P/E of the Dow Jones Industrial Average.
Regarding the relative tradeoff between bonds and stocks, O’Higgins observes a secular trend of higher inflation than the U.S. has experienced over the past 30 years, which has usually been toxic for bonds but beneficial for stocks.
“We’re obviously in an inflationary cycle, which is bad for bonds and good for stocks and precious metals,” says O’Higgins. “Companies can adjust to whatever the conditions are, as long as there’s a free market, but bonds cannot adjust.”
Analyst comment
Positive news: The Dogs of the Dow strategy has a proven track record of success, especially during bearish times. The strategy focuses on high dividend-yielding stocks that are temporarily undervalued, providing potential for both capital appreciation and steady income. The 2024 Dogs of the Dow have an average dividend yield of 4.2% and trade at a lower P/E ratio compared to the broader market. With the current inflationary cycle, stocks are expected to perform better than bonds. Overall, the Dogs of the Dow strategy presents an attractive investment opportunity with potential for long-term success.
