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Dogs of the Dow

November 15, 2017

I hate shopping but I love the stock market. When you think about how the market goes up and down – it is kind of like shopping. You pick things you like and are of good quality and then wait till they are on sale to buy them. That is the basic concept behind “Dogs of the Dow” - high quality, on sale.

 

Let’s start with a quick history of the stock market. When the TV networks say "the market is up today," they are generally referring to the Dow Jones Industrial Average. Named after the index's founder Charles Dow and his business partner Edward Jones, the Dow Jones Industrial Average was designed to serve as a sample of the performance of the broader U.S. economy.

 

Often referred to as "the Dow," the DJIA is one of the oldest, single most- watched indices in the world and includes companies such as General Electric Company, the Walt Disney Company, Exxon Mobil Corporation and Microsoft Corporation.

 

 

Today it is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ. Darn that was a mouthful.  Let’s break it down a little more.

 

The history of the Dow 30 can be considered a roadmap of the U.S. economy. The Dow components have evolved from the original “Dow Dozen” in 1896 to 30 stocks today, which show investors an overview of how the overall market is performing. In the beginning, the Dow primarily contained stocks in the commodity and steel sectors, including American Sugar, Standard Oil and U.S. Steel. As sectors evolved, the Dow has made a dramatic change to include a more diverse amount of sectors.

 

Since its inception, the Dow has changed components a total of 51 times. In 1932, the Coca-Cola Company and Procter & Gamble Co. were added to the index, two stocks that are still part of the Dow today. The most recent change took place on March 19, 2015, when Apple, Inc. replaced AT&T, Inc. General Electric (GE) is the only remaining original Dow component.

The Dow typically makes changes when a company within the 30 experiences financial distress and becomes less representative of the economy, or when a broader economic shift occurs and a change needs to be made to reflect it. Many of the original companies have ceased to exist.

 

At the Dow's inception, Charles Dow calculated the average by adding the prices of the 12 Dow component stocks and dividing by 12. Over time, there have been additions and subtractions to the index and changes to the calculation.

 

Since there are just 30 Dow stocks in the index, a single company has the ability of moving the daily performance of the Dow if its share price changes dramatically. During earnings season – which is late first Quarter when companies announce their performance for the prior year - many companies see a large fluctuation in price. That can have a big impact on the Dow.

 

Ok – I see your eyes glazing over. Enough with the history lesson. Lets get into the real thing you want to hear – how to make money in the stock market.

 

For decades I have used an investing strategy called Dogs of the Dow which I learned from Michael Higgins in his book, "Beating the Dow". The strategy's simplicity is what I loved the most about it.

 

It is so easy – you invest in the 10 of the 30 companies in the with the highest dividend yield. So what do I mean by that? The yield is the amount of the annual dividends paid by the sock divided by the price on that day. You can find the annual dividends listed on dividends.com.

 

Here is an example: IBM will pay $6.00 per share in dividends this year. It is currently trading at $149 per share. If you divide $6 by $149 you will get 4.02%. Meaning your return on your investment of $149 will be 4% per year just on dividends paid.  The website dividends.com lists the price, dividends and yield of the Dow each day so you don’t have to even do any math.

 

Just take the chart and pick the top 10 yielding stock and buy an even dollar amount of them. On the same day each year you do the calculation and make changes as necessary. I do this the week of my birthday each year.

 

Now when I first started I did not have enough money to buy shares in the top 10 – I started with 3. I had $1000 and split it among the three companies. I bought 35 shares of Walt Disney which was trading at $9.28, 55 shares of Caterpillar which was trading at $6.00, and 40 shares of Coca Cola which was trading at $8.38 – investing about $333 in each stock. Over time, as I saved more money to invest I moved to 10 from my original three. I personally have 1/3 of my portfolio invested the “dogs”.

 

Is it Really that Simple?

Yes, this strategy really is as simple as it sounds. On your same day every year, you reassess the 30 components of the DJIA, determine which ones have the highest dividend yield, and make your portfolio as equally weighted in each of these 10 stocks as possible. Hold onto these 10 stocks for one calendar year and repeat the process. This is a long-term strategy, requiring a long period to see results.

 

Does it work?

Yes - The performance in the last 20 years returned 20.3% annually, whereas the Dows averaged 15.8%.

 

 

Why does it work?

The premise of this investment style is that the Dow Dogs, which are temporarily out-of-favor stocks, are still good companies because they are still included in the DJIA; therefore, holding on to them is a smart idea, in theory. Once these companies rebound and the market has revalued them properly (or so you hope), you can sell them and replenish your portfolio with other good companies that are temporarily out of favor. Companies in the Dow have historically been very stable companies that can weather any market decline with their solid balance sheets and strong fundamentals. Furthermore, because there is a committee perpetually tinkering with the DJIA's components, you can rest assured that the DJIA is made up of good, solid companies.

 

What would that list might look like today?

 

 

If I had to pick 3 they would be Verizon, IBM and Exxon Mobile.

 

Telecom giant Verizon (NYSE:VZ) is perhaps my single favorite stock for investors whose top priority is income. It pays nearly 5% per year, and its dividend is backed by reliable cash flow generated from its subscribers. In fact, Verizon's dividend represents about 62% of 2017's expected earnings of $3.75 per share, so the company could even absorb a significant earnings drop and still maintain its dividend payment. The stock also has a history of low volatility, so it can produce a bond-like income stream, while still allowing you to sleep soundly at night.

 

Another favorite on the list is tech giant International Business Machines (NYSE:IBM), better known as IBM.  "Big Blue" has fallen out of favor with investors, and its share price has fallen by 16% in the past three months alone, fueled by weaker-than-expected earnings in April and a downgrade of its credit rating in May.

 

However, picking up shares of IBM now while the price is low could be a smart idea. IBM's cloud-related business is thriving and has room to grow. This company could turn out to be an excellent value play for patient investors. 

 

Oil isn't going away any time soon and ExxonMobil (NYSE:XOM) is one of the largest oil companies in the world, and is among the top dividend payers, as well. Not only is ExxonMobil's dividend one of the highest in the Dow, but the company has a 34-year track record of dividend increases, no matter what the economy or the price of oil was doing. To be clear, I'm a fan of both oil stocks on the list (Chevron being the other), but I think ExxonMobil's size gives it a bit of an advantage.

 

However, if I only had my original $1000 to invest I would buy 10 shares of Verizon, 5 shares of Exxon Mobile and 10 shares of General Electric. After all General Electric started on the original list and is still in the top ten more than 100 years later.

 

Dogs Not Fool Proof

As is the case with the other strategies, the Dogs of the Dow strategy is not fool-proof. The theory puts a lot of faith in the assumption that the time period from the mid-20th century to the turn of the 21st century will repeat itself over the long run. If this assumption is accurate, the Dogs will provide about a 3% greater return than the Dow, but this is by no means guaranteed.

 

 

Conclusion

The Dogs of the Dow is a simple and effective strategy based on the results of the last 50 years. Pick the 10 highest yielding stocks of the 30 Dow stocks, and weigh your portfolio equally among them, adjusting the portfolio annually, and you can expect about a 3% outperformance of the Dow. That is, if history repeats itself.

 

***As a disclaimer – I am not an investment advisor and am not providing investment advice. I am merely giving you the benefit of my personal experience in investing.***

 

Until next week

Live Rich!

 

 

 

November 15, 2017

 

Join me every Wednesday on my podcast “Unlocking the Secret to Living Rich”.

 

If you have questions or comments you can contact me at my email cindy@cindybbrown.com or find me on Facebook, Twitter or Instagram @cindybbrown777

 

Who is Cindy B. Brown? Cindy is a CPA, MBA, CFO, board member of public and private companies, business consultant, entrepreneur coach and a foremost

expert in the field of financial mastery. Cindy’s purpose is to motivate, educate and inspire people to live their richest life. Host “Unlocking the Secret to Living Rich”.

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