A funny thing happens on January 2nd of every year. Hundreds and thousands of investors wake up and run to their computer like it’s Christmas morning. They’re in a huge rush to do a few quick calculations and determine their investment strategy for the new year. Based on this little bit of math they blindly make all of their investment decisions.
It’s a simple strategy. With a strategy based on the stocks that make up the Dow Jones Industrial Average, these investors are looking for high dividend yields. Their hope (like every investor) is to outperform the market.
So, what strategy am I talking about?
The “Dogs of the Dow” investment theory of course. In 1991 Michael O’Higgins published a book called “Beating the Dow.” Michael, according to his own biography, is widely considered one of the best investment managers in the US. He started on Wall Street in 1971 and founded his own money management firm in 1978. In this book he put forth a very simple strategy of buying the 10 Dow stocks with the highest yields.
Over the long-term, say 15 years, the Dogs of the Dow strategy had outperformed not only the Dow Jones Industrial Average, but the S&P 500 as well. Sounds great, huh?
The problem… it doesn’t work so well anymore.
In the last 5 and 10 year periods, the strategy actually underperformed the market. In the go-go days of the internet, people were less focused on traditional businesses that paid dividends. As a result, the strategy failed to beat the averages. Further, in 2004 and 2005, the strategy failed again – miserably.
Then in 2006 the strategy performed well, outperforming by 10%. This, unfortunately, brought renewed life to the Dogs of the Dow.
In 2007 the results were again unimpressive. The top 10 companies selected this year included: Pfizer, Verizon, Altria, AT&T, Citigroup, Merck, General Motors, DuPont, General Electric, and JP Morgan Chase.
A basket of these stocks, one share each, would have cost approximately $427.50 and you would be able to sell them today for $424.12. Including dividends the strategy returned a measly 3.5%.
The Dow as a whole is up this year almost 7% . . . not including dividends.
Just investing in the Dow outright would have produced better results than following the Dogs of the Dow strategy. Why did the results in 2007 fail so miserably after such a good 2006? You can directly tie the poor results this year to two stocks Citigroup (C) down 47% and General Motors (GM) down 17%.
A wolf in sheep’s clothing?
In reality this famous trading strategy is a simple one. It’s a very basic value strategy. These stocks are traditionally trailing the market but still have great businesses with some inherent value. On the whole, they tend to be out of favor for some reason. This makes them value plays. Ah, but we know value investing tends to time…sometimes more than 1 year.
And right now, the market is favoring growth stocks.
So here we are at the last trading day of 2007. Tomorrow, a new batch of stocks get selected for the Dogs of the Dow and investors the world over start their investing strategy all over again.
I suggest you leave the “dogs” to someone else.
Resist the urge to select stocks purely on one data point – it will save you lots of pain down the line. Look at the strategic reasons behind each investment rather than blindly following a general strategy.
You should never just buy or sell a stock only because of its yield, try to understand the company and its industry. With a little additional research I truly believe savvy investors can beat the market over the short and long term.