8/12/2014
By Jennifer Coombs

A few months ago, I outlined this investment strategy to illustrate that it is possible for investors to build a portfolio in difficult markets that will outperform even well-diversified mutual funds. More than anything it proves that some careful planning and digging can allow even the most risk-adverse investors make money in bearish markets. There are dozens of strategies out there, but here is a simple concept for beginners…

Following the wounds sustained during the Tech Bubble at the turn of the millennia, few people ever expected internet and technology stocks to soar to all-time highs again. A few months back, the Dow Jones Industrial Average was soaring to new all-time highs, and ironically enough, much of the success of the Dow is thanks to its technology components. Most of the technology components of the Dow have been labeled as the “Dogs” of the index. “Dogs” in this sense refers to the Growth-Share (BCG) business matrix where a dog is considered to be a company in a mature, slow-growing industry where the units typically "break-even" and barely generate enough cash to maintain the business's market share. If the growth is so low, why invest in them at all? The answer of course is that Dow components pay dividends – big ones.

The “Dogs of the Dow” is an investment strategy which was popularized back in 1991 by money manager, Michael B. O'Higgins. On an annual basis, O’Higgins suggested that investors create an equally-weighted portfolio containing ten Dow components whose annual dividend is the highest percentage of the company’s current stock price. This idea is that the blue chip companies usually don’t change their dividends to reflect trading conditions. Therefore, the dividend is seen as a measure of the average worth of the company, while the stock price ends up fluctuating through the business cycle. This means that the Dow components with a high dividend yield are near the bottom of their business cycle and are likely to see their stock price increase faster than lower yielding companies. Therefore, a portfolio with that annually reinvests in high-yield companies should outperform the market. The logic here 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. Based on this current calculation, here are the current “Dogs of the Dow”:

Clearly these “Dogs” are hardly considered slow-growing; not in this year, nor were they back in 2000 (although there have been dips since). Even for those investors who missed the market on the way up, this pullback, and all the ones going forward, are going to be vital to enter. As of March 2012, Business Insider noted that more than 84% of mutual fund managers underperform the market. Keep in mind too that any dividends made from these funds are likely canceled out due to transaction and management fees. It makes quite a lot of sense to consider the quality of a company, as well as what dividends mean for a company’s health.

Although not quite one of the current “Dogs” but definitely impressive with a 2.7% dividend yield, is Microsoft (MSFT). This company fit the definition of a “Dog” business perfectly since it was in a mature industry by the turn of the century and it wasn’t expected to ever reach its peak of $58 again. After bottoming in December 2000 following the tech bubble, many believed Microsoft was through and dozens of firms put it on the “Death Watch” list. The stock has returned 175.9% since that day. Even International Business Machines (IBM) and United Technologies (UTX) have returned triple-digit returns following the tech bubble.

Ultimately, this illustrates that even the technology components of the Dow still possess growth potential heading into the future. Despite market dips, even the “Dogs” that many feel are past their prime will still remain strong with impressive dividends. Woof.

Jennifer Coombs
Wall Street Strategies

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