The turn of every year is a special time. Not only because it feels like the old and especially bad is left behind and something new starts. There is also a well-known stock-picking strategy that promises you to beat the Dow Jones Index by only doing a few transactions at the start of each year. Did this low-maintenance strategy deliver in the past? And what are the picks for 2023 according to this strategy?
Summary and key takeaways from today’s Weekly
– The “Dogs of the Dow” strategy is easy to understand and implement for everyone.
– However, historical performance shows that an investment in the Dow Jones pays off more, because in good years the Dow massively leaves the Dogs behind.
– For the new year 2023, I am skeptical as to the Dogs.
Who does not dream of it? Beating the market effortlessly, not having any stress during the year, no matter what markets do (yes, including periods like the dot-com crash, 2008, 2018, 2020 and 2022), and this all with just a few transactions at the beginning of each year?
It gets even better.
You just buy these stocks with a ready to go recipe without having to do any meaningful research. They already get pre-selected for you. The only thing you have to do, is just to know where to look and pull the trigger.
If you have some experience, this could even be done in 10–15 minutes – inclusive of placing the orders. That would be all your working effort you’d have to invest for 2023 – at least according to this 31-year old strategy.
Is the good nose for lucrative investments dead?
But does this three century old strategy still stand the test of time? The constituents of the Dow Jones Index changed many times since the original publication.
Some companies even went bust.
Does anyone remember General Motors before the Financial Crisis 2008 hit? It was a darling of many. For those that do not know: GM went bankrupt. Today’s GM came out of insolvency and went public again (ISIN: US37045V1008, Ticker: GM). Old shareholders lost everything.
Or what about Bethlehem Steel a decade prior?
Today, the Dow contains more asset-light technology and less capital-intensive industrial companies than in the past.
The first Weekly of 2023 is going to explain the basic idea of the “Dogs of the Dow” strategy, of course examine its historical performance record for the last 27 years and give an outlook for the current dogs of 2023.
Leash off and go.
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Who let the dogs out?
Michael B. O’Higgins from independent money management firm O’Higgins Asset Management, Inc. is the first to mention this strategy in his 1991 book “Beating the Dow” and giving this particular strategy its name.
The idea is so simple that it perfectly fits into my scheme of simplicity.
As my readers know, I dislike complexity and prefer investment cases that are easy to understand. My task is not only to find those, but also to present you those ideas in a concise and well digestible way. This doesn’t mean that no research needs to be done – quite the opposite. But you have to get to the core and compress the gathered information into a firm investment thesis.
What is better understood can be more trusted.
I would go even one step further and claim that the best ideas are often the simplest ones – not the complex and quirky that many people do not understand. I myself, also do not understand every business model (if there is any).
You need trust and confidence in your strategy and with your individual investments. The Dogs of the Dow strategy comes in handy insofar as not only the concept is pretty simple. It is also a very low maintenance plan where you just need to adjust your portfolio once a year.
The core spins around dividends.
Without cheating: Could you tell how many of the 30 companies in the Dow Jones are currently paying dividends (or how many are not)?
The answer comes below the picture.
Currently, 27 companies of the Dow Jones are distributing cash and three are not.
However, of the three withholders, only one has never paid out cash to its shareholders – Salesforce (ISIN: US79466L3024, Ticker: CRM).
The other two, namely Boeing (ISIN: US0970231058, Ticker: BA) and Walt Disney (ISIN: US2546871060, Ticker: DIS), dumped their dividends both in 2020 without restating them until present, because they needed the money otherwise. As it seems, Boeing paid its first dividend already in 1937 (see here), while Walt Disney was paying out dividends at least since 1989 (according to this source here).
At the start of every year, you pick those ten stocks from the Dow Jones Index that have the highest dividend yields with an equal weight each.
Why the highest yields? Aren’t they rather signs of stress and a good contra-indicator?
The main assumption is that those companies that are constituents of the Dow Jones Index are – rightfully so – the biggest, most grown-out and also financially most robust companies.
The golden trophies so to speak.
They are also called the “Blue Chips”. With them, you barely should do wrong.
Once a dividend is implemented, these companies tend to commit to their payouts. At least I don’t know of a Dow company that in one year pays a dividend, but not in the next one. At least, for as long as outside forces don’t allow for a continuation anymore.
One step further and as an argument against the seemingly plausible thought that the highest dividend yields do not come without a rather negative reason, the second pillar of this strategy is that a dividend is likely to fluctuate less than a share price.
Why is this of importance?
The dividend, being way more stable than the share price and often even raised on a yearly basis, is a better barometer or proxy for the phase of the business cycle that the company is currently in.
It is no secret that over the longterm the share price follows the earnings of a company. When a company is doing well, usually its share price does too. This lowers the dividend yield, as it is measured against the (higher) share price.
To the contrary, in a more challenging or even economically difficult environment, share prices tend to fall. This, however, increases the dividend yield of a company which likely has the worst already behind it.
With this approach, the assumption is that a company that is in a lower stage or even near the bottom of the business cycle (and with its lower share price as well as higher dividend yield), offers more upside potential, compared to those stocks that already had a good run up.
At least in the past, this was the playbook.
Here is a graphic to visualize the idea:
Like every other strategy, too, also the Dogs of the Dow have their flaws.
For example, the question of the sustainability of the dividend is never asked.
It is just assumed that the majority of the companies will continue to pay their dividends, no matter what happens operationally. Those stock picks that cut their dividends or even generate massive capital losses, are balanced out by the winners.
There are several questions that challenge the sustainability of this strategy.
Will the series of many uninterrupted payouts and frequent raises continue as we had 40 years of falling interest rates that have come to an end? Many companies are facing massively higher refinancing costs, i.e. their interest payments will rise down the road. This self-explanatory lowers cash available for dividends.
A second point to think about is the rotation of constituents.
When a company leaves the Dow Jones – for whatever reason – you will have to sell the stock early next year. But maybe it would have a high enough dividend yield and a business that is strong enough and should be held?
One of the best examples that comes to my mind immediately, is Exxon Mobil (ISIN: US30231G1022, Ticker: XOM) which had to leave the Dow Jones in 2020 after the unprecedented fall of the oil price. The stock had one of the highest dividend yields and its stock appreciated among the most subsequently, only to reach new all-time highs during 2022.
The Dogs of the Dow strategy is not perfect – like no strategy is. It is first and foremost about an approach that can be easily replicated by everyone.
We’ll look at the performance in the next section. But keep such things in mind, as past performance is never an indicator for the future. You could for example modify the strategy slightly, if you feel unsure about one of the proposed picks.
What has worked, works for so long, until it stops working.
So, how to apply it in practice?
In practice, if you had a portfolio of let’s say 100,000 USD, at the start of the first year, you would buy for 10,000 USD each of those stocks from the Dow Jones Index with the highest dividend yields.
Then you wait for the year to pass while collecting your payouts.
Obviously, next year the winners with a good performance and sinking dividend yields get sold with a capital gain and free up munition for new purchases. The new top 10 with the highest dividend yields get bought each for 10% of the total portfolio.
But it can also happen that some of last year’s dogs stay for another ride.
Where to get the picks?
If you wish, you can calculate for yourself, but there are many pages on the internet that have already done the job for you (maybe check on several sites).
An example is the website of the Dogs of the Dow (see here). Yes, there is even a website that only deals with this topic. They have lists ranging back until the end of 1995 for the 1996 Dogs of the Dow season. However, the years before are not available…
With that, let’s examine the past performance of this strategy.
Historical performance of the Dogs of the Dow
Note: For the Dow Jones, I took the performance numbers of the whole index, not of the individual constituents from the prior year.
Although it didn’t happen in the recent past too often, earlier there were more changes in the Dow Jones from one year to the other, as companies like Bethlehem Steel, Eastman Kodak, AT&T, General Electric, Hewlett-Packard or General Motors – most of them dividend paying companies – either went bust or fell massively and subsequently left the index.
What is solved rather sub-optimally, is the weighting-procedure. The company with the highest stock price has also the highest weight in the whole index. This way, currently, Apple is only number 20 in the index of 30 (see here for the whole list).
As there was no ready-to-go overview available as I would have liked it, I created it myself and used the performance numbers from the tables of the website of the Dogs of the Dow (see here).
Unfortunately, although the strategy was already presented in 1991, the data on the website only starts with the end of the year 1995, i.e. for the “1996 season”, if you want to call it that way.
Typing in all the data into one table plus calculating the stock performance of the Dogs of 2022, brings us the following results – let’s start with some numbers for warm-up:
The first result to take home is that over 27 seasons, in 17 cases an investment in the Dow Jones Index would have brought an outperformance. That’s a hit rate of 63% – not bad.
To the contrary, only in 10 out of 27 years, the Dogs outperformed the whole index.
What could be a plausible explanation?
Short answer: There is no secret recipe for when it would have been better to reliably switch from one strategy to the other so that you always get the better performance.
But what seems to be often the case is that during booms (into the Dot-com crash, into the housing-bubble and into the last big rally until the current market corrections), the Dow Jones outperformed the Dogs.
Not only slightly, but by a very wide margin, if you look closer at the numbers.
There is no single year, where the blue column of the Dogs massively outperforms the Dow, only slightly, if ever. But the Dow had some years where it crushed the Dogs – see 1998, 1999 and 2019–2021.
Plus, what is not so obvious at first sight: The Dogs lost way more during the 2008 meltdown, which seems rather surprising.
Remember? The more you lose, the disproportionately more you have to gain back, just to break-even again?
On the other side, it would be thinkable to assume that the Dogs outperform when there is stress in the markets, i.e. during corrections. The argumentation could be that the Dogs have already the vast part of their individual correction behind them and thus a higher margin of safety.
Or a more favorable downside / upside probability.
This even seems to be true, but not always. During the bursting of the Dot-com bubble, in 2018 and 2022 it worked well. But I have no explanation why the Dogs achieved higher returns in most years of the last decade and likewise during high-return years like 2006 or 2013.
What about a hypothetical investment of 10,000 USD in each of them at the start of the 1996 season?
The Dow Jones really crushed the Dogs over the last 27 years.
The comparison is not perfect, as there are is a brake put on the Dogs. They have higher dividend yields and thus higher payouts. These payouts would be reinvested in practice and lead to higher returns.
But here, we are one comparing the price evolution.
In this face-off, neither dividends from the Dow, nor from the Dogs, are being taken into account. But also, with the Dogs strategy – to be fair – you would have higher transaction costs as well as taxes for capital gains and the higher dividends.
These would eradicate most of the advantage of higher dividend yields.
With a one time investment in the Dow, you wouldn’t have transaction costs, except at the beginning and once a year for reinvesting the dividends (but as said, in this calculation they are completely left out).
And you wouldn’t have any capital gains taxes, because no position would have been sold actively by the Dow investor. Likely, an investment into the Dow Jones would be done via an ETF, and not via 30 individual positions.
Thus, we can leave it this way as a rough proxy.
Concluding until here, it seems as if the Dogs of the Dow are rather running behind than being a return leading strategy.
What about about the propositions for the new year?
Dog-picks for 2023 and comparison to 2022
Here is the list of the names for 2023 together with the respective dividend yields, as of year end (and assuming they stay the same which won’t happen in all cases):
On average, with this line-up you would enter 2023 with a 4.5% dividend yield.
This is the third-highest dividend yield since 1996. Only at the end of 2005 (4.7%) and the meltdown-year 2008 (6.2%) you would have had higher yields for the next year – in case there were no cuts.
In comparison to 2022 (at the end of 2021), there have been the following changes for the new 2023-season:
- Merck & Co. (ISIN: US58933Y1055, Ticker: MRK) leaves the game after a strong 2022
- Coca-Cola (ISIN: US1912161007, Ticker: KO) also dropped out
- entering the list is Cisco Systems (ISIN: US17275R1023, Ticker: CSCO)
- as well as JPMorgan Chase (ISIN: US46625H1005, Ticker: JPM)
The yields of Merck and Coca-Cola both dropped below 3% which wasn’t enough to stay on the list for 2023. They got replaced by Cisco and JPMorgan with dividend yields of slightly more than 3%.
A very close race.
And to be honest: I would rather have kept the first two in the portfolio than switching to the new ones. But that’s only what I think. I don’t own any of those stocks currently.
All in all, the Dogs outperformed in 2022. The strategy has worked last year (–1.8% vs. –9.5%). But for the most part due to two and a half big outperformers that went against the overall trend, namely:
- Chevron (ISIN: US1667641005, Ticker: CVX) with +53%
- Merck with +44.8%
- and Amgen (ISIN: US0311621009, Ticker: AMGN) with +16.7%
As you can see from the following table, there were some heavy, above-average (compared to the Dow Jones) losses in this group of the Dogs:
Like everyone else, I do not have a crystal ball to forecast the outcome for 2023.
My primary reasoning was the high debt-load together with the meaningfully higher interest rates now that only make refinancing activities more expensive. Please check those two articles, if you haven’t already and are interested in more details.
This way, my guess for this year would be rather that the Dow Jones outperforms, because dividend cuts would cripple any of these stocks.
The “Dogs of the Dow” strategy is easy to understand and implement for everyone.
However, historical performance shows that an investment in the Dow Jones pays off more, because in good years the Dow massively leaves the Dogs behind. The smaller outperformances of the Dogs are not enough to gain back the underperformances of the other years.
For the new year 2023, I am skeptical as to the Dogs.
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2. ca. 8–9%, things to know here
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–> on average: 8.6%
(all numbers as of date of publication)
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