The Dogs of the Dow: Consider the Middle Way

Schaeffer's Investment Research
  JAN 03, 2013 4:05 PM

A long-term study proposes a new spin on the Dogs strategy.


With the New Year comes lots of talk about the Dogs of the Dow. You can read more about the theory here and here, but it is simply annually buying the 10 stocks in the Dow (INDEXDJX:.DJI) with the highest dividend yield.  The thinking goes the companies with the highest yield (dividend relative to stock price) are near the lows in their business cycle and should see strong price appreciation.

Normally, the highest yielding names are also some of the worst performers – as yield and price are inversely related. So does it make sense to buy previous laggards?

Bank of America (NYSE:BAC) has made some headlines recently, as it was the worst Dow performer in ’11 and was the best performer in ’12.  At the same time, Hewlett-Packard (NYSE:HPQ) was one of the worst performers two straight years. Here is a list of all the returns the past two years.

As I noted last week, buying stocks that were up 100% the previous year is actually a good strategy – as they tend to continue to lead the next year. So let’s take a look this week if buying previous laggards for a potential bounce makes any sense.

Breaking this down a little more, if we take a look at the top five, middle 20, and bottom five performers from ’11, the laggards indeed were some of the strongest performers last year on average. At the same time, only three out of five were even positive, suggesting the results were skewed by a big winner or two (thank you, BAC).

Unfortunately, taking a longer-term look at this suggests buying the worst five performers isn’t going to produce much in terms of outperformance and last year was the exception not the rule. Interestingly, buying stocks in the middle of the pack is actually the best strategy.

None the less, here are the returns for all the Dow stocks last year. Could we see a repeat of last year? If so, taking a closer look at some of those laggards could be a nice approach. But in the end, I’m not so sure simply buying laggards is the best way to make money in ’13.

This article by Ryan Detrick, CMT, was originally published on Schaeffer's Investment Research.

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