Dogs of the Dow
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The Dogs of the Dow is an investment strategy popularized by Michael B. O'Higgins, in 1991 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.
Proponents of the Dogs of the Dow strategy argue that blue chip companies do not alter their dividend to reflect trading conditions and, therefore, the dividend is a measure of the average worth of the company; the stock price, in contrast, fluctuates through the business cycle. This should mean that companies with a high yield, with high dividend relative to price, are near the bottom of their business cycle and are likely to see their stock price increase faster than low yield companies. Under this model, an investor annually reinvesting in high-yield companies should out-perform the overall market. 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. Of course, several assumptions are made in this argument. The first assumption is that the dividend price reflects the company size rather than the company business model. The second is that companies have a natural, repeating cycle in which good performances are predicted by bad ones.
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, their data claimed to show 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 20 years from 1992 to 2011, they say Dogs of the Dow matched the average annual total return of the Dow (10.8%) and outperformed the S&P 500 (9.6%) as reported by the Dogs of the Dow website located at dogsofthedow.com. However, other commentators have pointed out that the Dow Jones Industrial Average (DJIA) is a price weighted average, and that the Dogs of the Dow data that has been used are not. These data sets are therefore not comparable, and if the Dogs of the Dow is similarly weighted to support comparison, the results reveal consistent underperformance as reported here. Furthermore, because the Dogs of the Dow system holds shares in only ten companies, systemic risk is greater, and because it requires annual re-balancing, trading costs and tax liabilities are likely to be higher. The Small Dogs of the Dow, which are the five lowest priced Dogs of the Dow, have been claimed to have outperformed both the Dow and S&P 500 with an average annual total return of 12.6%, however these comparisons were also invalid for the reasons stated above. 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 (1998 and 1999) as well as during the financial crisis (2007-2009). While most any investor can back test an investment system that performed well over the recent past (data mining), what is remarkable about the Dogs of the Dow in this regard is the way in which forward testing for over two decades (including multiple booms and busts) have been trumpeted using invalid comparisons between price adjusted and non-price adjusted data.
A full analysis can be found here.
- Michael O'Higgins and John Downes (2000) Beating the Dow (Revised and Updated). Collins, ISBN 0-06-662047-3
- Dogs of the Dow has been tracking this investment strategy since 1995.
- Latest performance of the Dogs of the Dow
- Dogs of the Dow and the 'Foolish Four'