Dogs of the Dow Strategy Continues to Impress Investors
A lot of investors are intrigued by the Dogs of the Dow strategy, which goes with the top 10 dividend yielding Dow stocks and beats the market. This doesn’t mean it’s that great though.
Looking to beat the overall market is a goal of a whole lot of investors, including the great majority of those who don’t just choose to follow it by holding index funds. When presented with a simple strategy such as holding the top 10 dividend yielding stocks in the Dow on a yearly basis, and when told that this has proven to be a fairly reliable way to beat both the Dow and the S&P 500, it’s not surprising that this turns a lot of investor’s heads.
Over the last 9 years, since 2010 onward, this strategy, called the Dogs of the Dow, has beaten both the Dow and the S&P by an average of about 1.5% per year. This may not bring on visions of retiring in luxury, but this does add up, and 1.5 times 9 adds up to 13.5%, which does mean something.
While this has all happened during an impressive bull market, and we may want to be a lot more wary of doing something like this in a bear market, since we’d be more likely to get some actual dogs by having the more distressed stocks in the Dow show their ugly faces on this list, this is plenty good enough to have us deciding that this does seem to provide an advantage over at least some index funds during the good times at least.
If we lived in a world where there were only two choices, the market or the dogs, and we also expected a bull market, then it would be sensible to choose the dogs since they have performed well enough over a long enough period to inspire enough confidence.
If it turns out that index funds lose because they are the bigger of two dogs, with other strategies yielding even better results, now we have some reason to pause and think. Indexes have been put on some pretty high pedestals, and this strategy at least goes outside that big box that holds the thinking of so many investors captive, to its credit.
This opens things up to alternatives though, as the big challenge is to get beyond the thinking that it isn’t good to look to be selective with stocks, even though that is a big myth. With this dispelled enough that we’d want to put our money in just 10 stocks, we become free to look at whatever else might be out there that beats these things.
The first thought that should come into our minds is how these dogs compare to the Nasdaq, especially given the licking that this index laid on the dogs in 2019, more than doubling their return. Beating the two smaller brothers of the big 3 U.S. stock indexes may be one thing, but beating their stronger brother is another.
Proponents of the Dogs aren’t going to do that though because they don’t like to be shown up, and if the conclusion ends up being that this beats and Dow and the S&P but not the Nasdaq, then the logical conclusion will point to tossing both the Dogs and these two other indexes. That’s no way to convince anyone to go with your idea.
If we like the fact that the Dogs have beaten the S&P 500 and Dow by 1.5% per year over the last 9 years, we should especially like the fact that the Nasdaq has beaten the Dogs by over 4% during this time. In terms of their relative performance to these two indices, 5.5% sure looks a lot nicer than 1.5%.
This is no small amount in total, and it adds up to 38% over this period and represents a much bigger differential than between the Dogs and their declared index opponents. They want to declare themselves champions while the real champion just throws them to the mat and stomps on them.
A lot of investors are just fine with investing in indexes, but when you ask them to put more effort into things than this, they often balk. The reach of the Nasdaq strategy is therefore greater, and in fact, much greater, where you can simply choose the identical strategy that index investors already use and just pick a better index to invest in.
There’s also the risk of investors messing things up when they pick up the keys to their portfolio like this. While this is as simple of an investing strategy to follow as they come, there is still a risk that some will embrace their newfound freedom and venture off the path and into the woods, and overestimate their competence, coming away with mud all over them.
The Best Approach Involves First Looking for It
There are all sorts of other things that we can do with stocks once we’re free to pick them, for instance being selective with sectors or a certain type of stock in an index like the Dogs do, including ones that show up the Nasdaq. If we are touting a certain approach based upon its performance over a certain period, and it gets clearly shown up by the performance of an even simpler strategy, someone’s right hand is being raised in the air here and it’s not theirs.
We may even wonder whether taking the highest 10 Dow stocks in terms of dividends is even the best strategy for distinguishing Dow stocks by dividends. What if we looked at how the lowest paying 10 did last year, just for fun?
While dividends are still common enough that, during bull markets, it is still predictive of strength overall, and this is why the Dogs strategy does work versus the averages, because this does indeed select above-average strength among those components with a similar dividend strategy.
However, times are changing, and as more and more good companies rethink this, instead choosing to hold back some or all of what they could pay out in dividends, we will continue to move away from being reasonably assured that we go dogs that are at least a little above average overall.
2019 did not see the Dogs have the upper hand and the year essentially ended in a tie with the Dow, although they got spanked by the S&P 500, and by the Nasdaq even more. We’ve had a lot of acceleration away from proportional dividends lately though, and this has really picked up in 2019.
This phenomenon is made even clearer when we look at the growth of the Dogs in 2019 versus those who pay the least dividends, the side that has taken the ball now and starting to run with it.
The Dogs advanced an average of 15.5%, while the Low Dividend 10 moved up by 39.3%. While this may be a newer phenomenon, it is the current one, so if you are looking toward 2020, you don’t want to be leaning on a dated strategy when more relevant ones are available.
People become persuaded by ideas such as the Dogs of the Dow more by way of a stimulus/response mechanism than anything, perhaps sprinkling in a little limiting thinking such as these are the only two options out there, as well as a thirst for beating the market that is easily quenched.
The only interesting thing about the Dogs approach is to use it as a benchmark in the coming years to measure how quickly traditional approaches to dividends by companies is dying. The die has already been cast for a lot of top performers, where we likely have already passed the tipping point with the lower dividend’s star-studded stable, but this revolution will continue on.
We Are Quickly Moving Away from Relying on Dividend Rates to Express Strength
Restricting dividends also happens to be a better strategy if you want to grow the price of your stock, and this is what we are actually waking up to. Companies are even more focused on their stocks these days, and many consider things like buybacks, which only benefit shareholders, as a primary business strategy now, and even the most primary.
It may not quite be time to put money on this yet, but if it isn’t, that time is near. Stock price is how we keep score, so as more companies tend to them more by reducing their dividends, the correlation between dividends and performance will be turned on its head with the smart money changing sides.
The Dogs of the Dow are more like a sideshow at a carnival now, even though they may be portrayed as the main attraction. If and when we get a pullback, these really aren’t stocks that you want to be in. Declining markets push weaker companies to the top of this list, as their weakness bloats up their dividends, and not for the right reasons.
Dog is quickly becoming a genuinely appropriate word to describe this approach and the stocks it selects. If we do choose to follow them, we especially need to be aware that we are latching on to an approach that is moving from a state of advantage to a state of disadvantage, and then keep our eyes open and watch it happen.
Editor, MarketReview.com
John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.
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