The “Dogs of the Dow” is an investing strategy that involves trading only once a year, as the calendar rolls over. Over time, the strategy has a track record of slightly outperforming the Dow itself, beating the index in nine of the last 14 years, albeit by an average of 1%. But the strategy’s most attractive characteristic—aside from its catchy name—is its simplicity. All you do is buy the 10 highest-yielding stocks in the Dow Jones Industrial Average at the beginning of each year. Next year, you replace any stocks that are no longer among the 10 highest yielders.
Here are all the Dogs of the Dow for 2016:
You’ll notice that all but one stock (PFE) declined in calendar year 2015, which is part of the reason their yields are now above average. The theory holds that buying these underperformers now, when they’re cheap, will deliver long-term returns. The best performers in 2016 will see their yields decline (since yield = dividend/price) and be replaced by more “losers” next year.
For example, this year saw AT&T (T), McDonald’s (MCD), General Electric (GE) and Coca-Cola (KO) leave the list, after rising 1%, 25%, 21% and 0%, respectively, in 2015. They are replaced by Cisco (CSCO), IBM (IBM), Procter & Gamble (PG) and Wal-Mart (WMT).
The idea behind the system—buying high quality companies whose stocks have had a bad run—is sound, but the Dogs’ “outperformance” isn’t strong enough for me to endorse the system wholesale. However, I think investors can use the annual list of Dogs of the Dow as a short list of potential investments—and can also apply the principle to other high- quality stocks that aren’t in the Dow.
This year, I lean toward Verizon, IBM and the pharmaceuticals as potential buys from the Dogs list. Verizon (VZ) is the highest-yielding stock on the list, having been a “Dog” since the beginning of 2005. The stock’s decade on the list has included several very good years for the stock, so it’s worth asking if Verizon is really a “Dog” or just an unusually high-yielding component of the Dow. Either way, the stock could be a good addition to a long-term income-oriented portfolio today.
Verizon has very consistent revenue trends, solid margins and an excellent history of dividend growth, as shown by the orange dividend line in the five-year chart above. There are risks: debt levels are high and competition in the wireless space is fierce. But after a 7% decline in two years, today looks like a decent buying opportunity in this high-yield stalwart.
Looking beyond the Dow (which is only 30 stocks, and pretty stodgy ones), I think Target (TGT) also looks like a 2015 “Dog” worth owning in 2016.
The company is as high quality as anything in the Dow, but has declined 2% over the past year, despite beating analyst estimates in every quarter. I put TGT back on Buy for my Cabot Dividend Investor members earlier this week, after the stock delivered good relative strength in December and early January. Yielding 3%, TGT is an appealing bargain here for risk-tolerant investors.
Lastly, if you missed Jacob Mintz’s Cabot Wealth Advisory about covered calls earlier this week, I suggest you read it here. A lot of investors are wary of using options, but covered calls, also called Buy-Writes, are actually a very conservative strategy that can help you generate extra income from stocks you already own. Investors trying to live off their investment portfolios face a dearth of safe high-yield investments today, and writing calls is one easy, low-risk way to mitigate some of the challenges the Fed throws in your path. You can read Jacob’s simple explanation of how to do it here.
Chloe Lutts Jensen
Chief Analyst of Cabot Dividend Investor
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