Don’t rely on the ‘Dogs of the Dow’
Dividend strategy may no longer be your best friend
Dividend strategies on Wall Street go to the dogs in January. But there appears to be a better way.
I’m referring to the so-called “Dogs of the Dow” strategy, which calls for investing each January in the 10 stocks from the Dow 30 with the highest dividend yields. It got its name because the stocks it recommends are typically out of favor on Wall Street. Over many decades of backtesting, the strategy outperformed the Dow itself.
But a funny thing happened over the past decade. Over the 10 years through the end of last year, for example, the Dogs of the Dow strategy has produced a 6.8% annualized gain (as judged by the Dow Jones High Yield Select 10 Index), assuming dividends were reinvested. That’s 0.7 percentage points per year behind the dividend-adjusted return of the Dow Industrials itself.
The best-performing dividendstock strategy among those I monitor has done markedly better. This superior approach is the one recommended by an investment advisory newsletter called
Investment Quality Trends, edited by Kelley Wright. Over the past 10 years, according to Hulbert Ratings, its model portfolio of dividend-paying stocks has produced an 8.1% annualized return.
At the core of Wright’s ap- proach is the belief that higherdividend-yielding stocks aren’t necessarily better bets than those with lower yields. That’s because a high yield doesn’t necessarily indicate undervaluation. For example, a high yield might also mean that the company is in financial distress and that it could soon cut or even eliminate its dividend altogether. In that event, of course, its stock would plummet.
As an example, Wright, in an interview, referred to Eastman Kodak, the erstwhile giant of the photographic film industry that eventually, in the wake of the digital revolution, declared bankruptcy. Yet for several years in the early 2000s, it was one of the Dow Dogs. “All it took was a bear market, and an adherence to an obsolete technology,” Wright added, for this “Achilles’ heel” of the strategy to be revealed.
Another core principle behind Wright’s approach is that a given dividend yield means different things in different industries. Stocks of utility companies, for example, typically pay hefty dividends (an average of 3.2% currently among utility stocks within the S&P 1500 Composite Index, according to FactSet), while retailers often pay more modest dividends (an average of 1.8% currently). But that doesn’t mean you should favor utility stocks over those of retailers.
Putting these two principles into practice, Wright recommends that investors searching for attractive dividend-paying stocks focus only on companies rated highest for financial quality, and buy them only when their dividend yields are near the high ends of their historical ranges.
Take Chevron. Wright notes the company lost money over the last year and argues this means the company’s dividend is risky — especially in contrast to other firms that have earned money year-in and year-out.