Dogs Are A Man’s Best Friend: Part 1 of The Dogs of the Dow

THE BLIND SQUIRREL DIARIES

By theblindsquirrel, April 30, 2014

Greetings once again to all you GummieBulls and GummieBears! The Blind Squirrel here, coming to you this month with some musings on an investment topic I’m sure most of you have heard about in the past. Some may have used it as a basis for building an investment portfolio. And some of you have perhaps given it a quick look and discarded it as just being far too simplistic for your tastes. I’m talking about what is commonly referred to as “The Dogs of the Dow” theory of portfolio management.

I know this concept has been around since at least the late 1980’s and been beat to death time and time again by other writers, investors, and websites. Some like it. Some do not. Some find it an easy and productive way to run a portfolio without having to become an investment analyst and spend countless hours doing due diligence, research, and keeping abreast of day-to-day changes in the market or the individual issues involved. Some think of it as a cop-out in being a responsible investor due to the fact that it takes little thought to set up and maintain. Those of you who may be in that camp – and there are many well-informed, active investors who are members/followers of the Stock Gumshoe site (especially the Irregulars) that just discard the concept out of hand due to that very simplicity. Bottom line is that the theory behind the portfolio management philosophy it uses has both its fans and its detractors.

The thing of it is this…reading about the way stocks are selected for inclusion in the portfolio, the manner in which they are “managed,” and the historical results derived from following this process, is just that: reading. But when put into actual use, it usually doesn’t take long to find out that there is a lot more to it than meets the eye. If ever anything in the investment arena has met the truth behind the Peter Principal that states, “Nothing is as easy as it looks. Everything takes longer than you think. And if anything can go wrong, it will, and at the worst possible moment,” this could at times be it.

In this part one – which will be followed next month with part two –I am going to take you a lot further into this idea than other sites that focus on it tend to do. We’re going behind the curtain so to speak to see what actually occurs once an investor sets up his/her initial portfolio and the wheels began to turn. You’ll see that indeed, “Nothing is as easy as it looks.” And, “Everything takes longer than you think.” And sometimes, “If things can go wrong, they will, and at the worst possible moment.” I think you will find this to be an interesting journey of enlightenment about the Dogs of the Dow and how they just might have a place in your portfolio management systems.

Before I get to the heart of this, a bit of disclosure on my part is in order. I discovered this process in 1991. I began to actively use it with clients in 1992. I still use it on a personal basis today and keep something on the order of 15% of my personal investable assets in an account that holds only these positions. And last, yes, I am a proponent of the system and would recommend anyone give it serious thought as to becoming one way to manage a part of your overall financial assets. The “why” of that is coming later in this article. I only ask you pretend you’ve never heard of it before right now and open your mind to the possibility that maybe, just maybe, it could work for you.

That groundwork now laid, lets get this party started.

Who Let the Dogs Out?

It was summer 1991. I was in my seventh year as a Financial Advisor and had just been recruited to join UBS PaineWebber and move away from Merrill Lynch. My business had grown and I was feeling good about that. But at the same time I realized there was something lacking in my business plan to keep growth on track. I had begun to talk with some of the more successful and seasoned brokers about how they had managed to break through the “glass ceiling” of good-but-unexceptional production levels and on into those lofty heights that marked a truly successful FA. And what began to emerge was the idea that almost every one of them had developed some niche of product expertise that they could offer prospects and clients which few, if indeed any, other brokers could. It might have been managed accounts, or option trading, or muni bonds, or equity dividend approaches, or small business retirement plans – you name it. Sure, all of us could offer advice on any of these topics, but these brokers were different. They had dedicated themselves to that field of knowledge and went after it with a focused passion. They knew a lot about a little, and a little about a lot. I had been working with the idea that the way to excellence was to put the “know a little about a lot” part of that phrase first in priority. I was wrong. And I realized I had to find my specialty, the one thing I could learn more about than anyone else knew, and make that the centerpiece of my business. And from that I could branch out into other areas of need of the client. But what? What could I do that wasn’t already being done by many others?

That was when fate intervened.

I was reading some financial magazine one day and ran across a book review that caught my eye. There was a new financial book that had recently hit the shelves of booksellers entitled Beating the Dow. It was by Michael B. O’Higgins, an independent Investment Manager who ran his own firm, O’Higgins Asset Management, Inc., in Miami Beach, FL. He had done extensive research on a novel way to construct and run an equity portfolio that he called “The Dogs of the Dow.” I stopped by a local bookseller that evening, got a copy, and was up all night reading it.

I was hooked. Here was, I felt, my niche.

Note: You can still obtain a copy of the original book Beating the Dow by O’Higgins as well as his updated version, Beating the Dow; Revised Edition by going to the Barnes & Noble website. The original book is offered by various sellers for about $4.00 and the new edition is about $13.00. Plus S&H and tax of course. Anyone interested in this investment management theory would be well served by obtaining a copy of each and reading thoroughly.

It may seem simple today given all the coverage and widespread information about the Dow Dogs Theory that exists for me to have become so excited about it. But you have to remember, this was late 1991. Nobody, and I mean nobody, had even much heard of this technique much less be using it in one format or another as a way to run a portfolio. That was key to me. I could make it my own and not be concerned about having to compete with every broker and brokerage house on the street for clients that were suitable for it and interested. That would change over the ensuing years, but for that moment I had nothing but open ground in front of me. After spending some time doing my own back testing and examination, and finding that yes, indeed, the process did lead to returns that beat the DJIA most years plus having average annual returns of 5 – 10 – 20 years that were superior to the indexes, I got busy. I went through my book of clients, targeted those for whom I thought it a suitable investment that could meet their goals and risk parameters, and began meeting with them to explain the process and open new accounts with the Dogs forming the basis.

By mid-1992 I realized I needed some sort of marketing brochure. Like with anything else, clients (and especially prospects) always wanted me to “send them something” in hard copy to review. But even if they hadn’t asked I knew this was necessary if I was going to be able to take the idea to the levels I felt it could achieve for my business. It was back to the drawing board.

I knew this would be a challenge. All firms have a compliance department that oversee the activities of the firms brokers, especially any written communications between them and clients. Remembering the old saying that it’s easier to beg forgiveness than ask for permission, I wrote a marketing piece that described how the process worked, provided performance data tables going all the way back to 1972, and explained how the client and I would set the account up and run it. Then, when finished, I submitted a copy to compliance for review and prayed for approval. Amazingly enough, I got it. I was good to go. This process, which I called “The Dow Top Ten,” became the centerpiece of my business and enabled me to reach levels that I otherwise may have never gotten to. More importantly, it gave many of my clients a way to get involved in the equity markets with confidence, develop a steady and growing stream of dividend income, and not have to be concerned with constant decisions of buy / sell / hold in their portfolio.

FYI, next month, in Part II of this article, I will have the brochure for 1997 available here for you to see. It’s really the performance data that is interesting for you, not all the surrounding material about how I set the accounts up, client and broker rights and responsibilities, etc. But you might enjoy seeing that as well. If you had been a client of mine in the 1990’s, this would have quite possibly been shown to you if suitable. It will also give you a little more insight as to how I conducted myself and my business as a Financial Advisor.

Fun Facts: You might think that Michael O’Higgins, as a money manager, would be somewhat married to the idea of using the Dogs of the Dow process with his clients. After all, it’ s his brainchild. But you’d be wrong. O’Higgins is anything but a one trick pony. There have been many years since he introduced us to this equity management strategy that he hasn’t had a dime of his clients money in equities at all. He has used zero coupon Treasury bonds when rates were substantially higher in the 1990’s and rode the yield curve as it went down, earning clients gobs of money as the zeros increased in value. And varied other financial assets as well. You can find out more about O’Higgins and his firm by visiting his website. It’s a very basic site so don’t expect much more than bio and contact data plus several articles about his investment process in the past. But if you like what you see, and have a minimum of $1,000,000 to invest, I’m sure he’d be happy to hear from you!

Also, a little brain teaser: As I have reminded you all on many occasions, back in the day we didn’t have the luxury of anything at all like the internet on which to do research and find data. It took a ton of work to obtain what we could for even the simplest things – an an annual report, for example. When I started to investigate the Dog Theory I had to make all calculations by hand from data I could pull off corporate reports. It was labor intensive to say the least. But we did what we had to do to get what we needed. However, “The times, they were a’changin'”. The internet was being born and those new-fangled things called “websites” were appearing by the hundreds every day. But since nobody much had a personal computer at home – or even in an office for that matter – it seemed more a novelty than the life changing event it would prove to be. Then, one day in 1994, a new site cropped up that caught my attention. It had a really weird name, a name I thought silly considering that it was actually a financial advice site. One might think that, covering a topic as serious as that, the site owners would have chosen a somewhat more restrained name. It focused on only one thing: The Dogs of the Dow Theory. Now, do you know what that site was? I’ll give you a couple seconds to think. De de de de de de de ……. times up. Got it? It was – and still is – none other than “The Motley Fool.” That’s right. When the Gardner brothers started out in the financial advice business, their flagship offering was advice on how to run equities using the Dogs of the Dow theory. I felt very vindicated and confirmed. Then I felt a bit threatened. If all this info I had worked so hard to discover were simply thrown out there for anyone and everyone to see and use, what would that mean for me? Then I realized it would be more a help than a problem since so very few people at the time even had a PC to access it with, and fewer still would know what to do with the information once they had it in hand anyway. Plus, a lot of my work in terms of calculating returns and such was now being done for me. It was a win-win for my clients and myself. Things have changed a bit at the Fool since 1994. Not a hint nor sniff of the Dogs anywhere to be found. The brothers have moved on to more lucrative and complex matters. They have been replaced as a central info central info provider on the Dow Dog Theory by a site called, appropriately enough, DogsOfTheDow.com. Tons of data there on performance and portfolio composition over the years – but no talk about actually running a portfolio of this construct. And now you know how The Motley Fool came into this world.

Mary, Mary, Quite Contrary, How Do Your Equities Grow?

If I were to ask you what was the single, most fundamental rule of investing that had to be followed in order for you to become a successful investor, what would you say? There are many possible answers to that, all valid requirements to be sure. But in my mind there is one that stands above all others. It’s the ageless idea that you must “Buy Low, Sell High.” So simple, so easy to say – and yet so hard to do. The reason it is so hard to do is likewise simple: to “buy low,” one must in most cases buy when the news and business environment is unfavorable. That has the power to push a stock price lower. Then, when the worm turns for whatever reason(s), and the news is all good and the business is flourishing, the stock price rises in response. You already know that.

So, in order to buy low, in many instances you have to buy when the company is out of favor, the analysts have it on life support, the competition is crushing it, market share is eroding, earnings are falling, etc. And it is for all of those reasons that we normally stay away from whatever stock this might be. We simply are not wired to buy something that everyone else basically shuns. It goes against common sense. Would you buy a new car that got terrible reviews in the major automotive magazines? Would you purchase a new laptop that the geeks said had internal OS problems? Of course not. That would make no sense whatsoever.

We tend to carry that thought process over into the buying and selling of our equities in much the same way. We avoid troubled companies with bad news. We are attracted to companies that are basking in the limelight of favor and profitability. So what does that translate into for us if we follow that course in our investment accounts? It often means we are “buying high,” the exact opposite of what that cardinal rule I mentioned tells us to do. And we wind up later on “selling low” when the circumstances surrounding the company change and the news turns sour again. We lose money and wonder why this is happening to us.

To follow the “buy low, sell high” axiom you must adopt the mindset of the contrarian, the person who goes against the grain of conventional common sense. Making a decision to invest in a company when others seem to be suggesting you avoid it takes a lot of moxie. Some would say foolhardiness. They would be right if it was the automobile purchase that was the basis on which they judged, but often wrong when it comes to investments.

I got my first introduction to that concept around 1986. Forbes magazine ran an issue that had on the cover a picture of the man whom I most admired and respected as an Investment Manager and human being, Sir John Templeton. At that time, Sir John was head of his mutual fund group, Templeton Investments, and was considered to be the Dean of Mutual Funds. He practically invented that concept of pooling money into one pot, assigning a manager(s) to invest and supervise it, and thereby offer to John Q. Public an entry method into the markets that had pretty much been denied them in prior times. Sir John had proved himself to be adept not only at stock picking, but also at thinking “outside the box” for those years. He championed emerging markets and depressed companies at a time when few had any real idea what an “emerging market” was, much less knew how to invest in them. He was, and remains, my number one investment hero.

On the cover, alongside his picture, was a short quote from him. It read: “Wrong question: where is the outlook good? Right question: where is it terrible?”. The implication was clear. If you are seeking investment success, stop looking in places where everything is going great and prices have already been inflated. Instead, look in places where it isn’t. I cut that cover away from the magazine, framed it, and it hung on my office wall for the next 18 years. It was daily inspiration for me.

And that’s where following the Dogs of the Dow Theory kicks in.

The Dow Dogs theory works off the simple principle of yield. To determine the yield, divide the current annual dividend by current price per share and you get current yield. Yield will move higher when (1) the stock price falls or (2) the dividend increases. On the other hand, the yield will move lower when (1) the stock price increases or (2) the dividend declines.

A high yield is an indicator of one of two possibilities. Either the stock price has declined due to some set of circumstances that has negatively affected the business while the dividend they pay has remained constant or little changed. Or the company simply pays an extraordinarily high dividend to start with.

If the stock price has declined due to the first set of circumstances just given, then we may have an instance of being shown a situation that is signaling a contrary buy. The news is bad. The price is falling. The dividend is being paid, perhaps even increased. We have ourselves a “buy low” possibility in the making.

Setting up and running a portfolio using the Dog of the Dow process is simplicity defined. It requires only this:

Step 1: Using a table of data on the DJIA 30 stocks, identify the 10 stocks with the highest current yield. In a perfect world you do this on the first business day of a year, but in actual practice you can start anytime. Several studies have shown that this won’t make a meaningful difference in overall performance after a year or two, if at all. That will give you your starting lineup for investment.

Step 2: Decide how much you want to invest in the account, then spread that money equally over all 10 stocks. If you round up or down based on whether the actual number is above or below one half a share, that will usually smooth out and allow enough cash to remain to cover commissions. There will be a slight difference in the amount of money in each position but not so much to make any real difference.

Step 3: Relax. Let the system work. Don’t attempt to make any changes based on opinion about the company, market forecasts, or market action. This is a long term investment. Never forget that and turn it into something it isn’t supposed to be. Note: When I was working with clients using this strategy there were a couple things that did happen which caused me to go in and make adjustments to the holdings. Things like serious dividend reductions, or the company being dropped from the DJIA 30. I’ll have more to say about that in the next part of the article, so stay tuned.

But wait, there’s more!

Lest you may think otherwise, understand that using a direct yield-based approach to equity selection as your only metric isn’t usually a smart thing to do. You cannot just use that equation alone to make an investment decision. The only exception to that warning is the Dogs of the Dow strategy. Here we do use that as the be-all end-all measurement to determine what to own. Here’s why you must be careful using it in other situations.

As you know, companies are very different from one another in size (market capitalization), type of business, time in business, earnings growth rates, dividend policy etc. If you are going to compare apples to apples you need a universe of stocks that share some basic similarities. That’s why using the DJIA 30 stocks as that “universe” works so well for the Dow Dogs strategy. This universe of 30 companies is determined by the editors of The Wall Street Journal. The Journal is a part of the publishing giant Dow Jones & Co. They select from all US companies the 30 that they believe to be the best of a broad range of sectors and industries, striving to give representation to all major classifications. The stocks are “.. chosen as representative of the broad market and of American industry. The companies are major factors in their industries and their stock is widely held by individual and institutional investors.” (sourced from a statement by The Wall Street Journal Managing Editor at the time Paul E. Steiger, May 1996.) When making selections for inclusion or deletion from the index, the editors do not consult the companies, the stock exchange or any official agency.

This list of the 30 will and does get adjusted from time to time as the editors deem appropriate. Working within this short list of companies, though very different one from another in many ways, makes the comparisons more relevant and accurate.

Since any issue that can ever be included in the Dow Dogs portfolio must come from the DJIA 30 universe, we can have some assurance that we are comparing those apples with other apples.

Another Fun Fact: The Dow Jones Industrial Average was created my Mr. Charles Henry Dow on May 26, 1896. He devised the index with the help of his partner and co-founder of Dow Jones & Co., Mr. Edward Jones (no relation to the Edward Jones that founded the brokerage firm Edward Jones and Co. as far as I know). At the start the index had 12 companies: American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling and Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal and Iron, U.S. Leather, and U.S. Rubber. Only GE remains – 118 years and still the industry sector leader.

Thinking Like Sir John

As mentioned, John Templeton was a great believer in contrarian investing. If he felt that the circumstances that had caused a stock to decline in price was temporary and could / would be reversed in time, he became a buyer. Buy low, remember? Using the yield as our indicator for when a stock price has become “low” relative to other somewhat similar companies is the way the Dow Theory functions. It forces us to do what is otherwise an unnatural thing – go against the current opinion and be a buyer when others are sellers.

But let us not get ahead of ourselves here. Because a stock has declined to a point where the yield places it in the 10 highest yielding category does not mean it has reached its absolute low. What drove it down could continue to push it lower still. How much lower, and when might the turnaround start, cannot be predicted by this management and selection system. Or, for that matter, can any other I have ever come across. Many claims are made that refute that based on some short-term success, but I know of no process that can demonstrate that ability over long periods of time, say 20 years or more of constant and continuing success. So we just have to go with the system, make the buys when indicated (as hard psychologically as that can be to actually do), and then wait. It may fall even lower. It may have already turned and be headed back up and off the list. Or it may simply hover at or near our entry point for quite some time as the situation evolves and gets resolved.

Meanwhile, Back on the Ranch

While we wait for this anticipated price improvement there is one very important thing going on in the background: the dividend. That’s our paycheck as owners. It’s the compensation we get for supporting the company in general, and the confidence we have in the management team that is there to make the decisions that guide the company forward. The management works for us – not the other way around. I know that sounds a little high-falutin’ – the idea that Meg Whitman, CEO of Hewlett Packard (HPQ) or Jeffery Immelt, CEO of General Electric (GE), works for you and your benefit. But that is the truth of it. Stockholders – I tend to prefer the term “Stakeholders” – are the owners of the business. Little, tiny parts to be sure for 99% of us. But owners nevertheless. The beauty of that dividend is that when times get rough, the dividend is steady as she goes in most instances. Maybe even getting larger as we wait. Patience pays.

Many of my clients who got involved with the Dow Dogs management process were attracted to it primarily due to the relatively high income those dividends gave them as they waited (hopefully) for the capital gains to kick in. Odd as it may seem, some were much happier when I called them to say that one or another of the companies they held had just announced a dividend increase than they were if I called to say the stock price had moved up a couple percentage points based on some sort of good news. It was that growing stream of income they loved.

A short comment on the importance of dividends is warranted at this point. It applies not only to Dow Dog stocks but to investing in general.

We all know that dividends add to the total return we get from owing stocks. The other part of that is, of course, price appreciation. Of the two components, the dividend is by far the most reliable and predictable. Barring quite unusual circumstance, that dividend will at least remain constant at current levels, but in many instances will be increased in a year-over-year manner. No guarantees of that, of course, but a historically fair statement to make. Price appreciation is far less certain and predictable. We expect that, of course – otherwise why buy the stock in the first place? But steady and predictable? I don’t think so.

Here’s a market historical fact that many people don’t know or recognize. They ought to. It’s this: Over time, when looking at total returns on dividend-paying stocks, you will find that the dividend itself contributes as much as ~45% of the total return the investor receives. That’s not a number for each and every year, mind you. It’s a number that has been demonstrated by numerous studies to hold true when viewed over 10 and 20 year holding periods. Even so, it points out one critical fact: dividends matter! Since dividends play such a critical role in the Dogs of the Dow Theory, an investor will by definition be putting herself in position to benefit from that.

I used to have tables and articles documenting that assertion. Time – and four or five business and residence moves – have claimed them as lost property. I can’t therefore post up here actual copies for verification. But I can do this: I can refer you here to a recent article that discusses the importance of dividends, the risks and returns that a dividend-based portfolio offers, and much additional sophisticated and detailed analysis of the subject. For serious investors I would recommend you visit this site and read the article.

From Seeking Alpha. “Why Dividends Matter: A Review of Recent Research,” by Geoff Considine, March 4, 2014.

“… portfolios formed on the basis of dividend outperform the broader market on a risk-adjusted basis.”

“These portfolios are sacrificing nothing, except exposure to certain industries and sectors that pay no dividends.”

“… dividend portfolios are low beta portfolios that also provide income.”

You can see the full article, here

Note: This is not an article covering the actual Dogs of the Dow portfolio, nor is it an endorsement of that particular strategy. It is broader in scope and talks about the dividend difference inherent in any dividend-paying stock, not just those in the Dogs of the Dow portfolio.

The Results

I could fill the next ten pages of this message with stats and data going all the way back to 1972. Don’t worry – I’ll not subject you to that torture. But some results are necessary at this juncture so you can see for yourself what has happened for investors involved in this process. Be advised as always; past results are not a guarantee of future performance.

To began I need to make you aware of one thing I’ve noticed regarding published performance statistics that is not easily recognized unless you read the footnotes that accompany them. Most – actually all – of the performance results I find omit the dividends that are paid by the component issues in the Dow Dog portfolio as well as the comparative indexes. I have no idea why the publishers of the data do that. As I just discussed, over long periods of time the dividend component will provide a substantial portion of the total return. With that in mind, the following are a few sets of return statistics for you to consider.

Investment 2006 2007 2008 2009 2010 2011 1yr 5 yr 10 yr 20 yr
Dow Dogs 30.3 2.2 -38.8 16.9 20.5 16.3 16.3 3.4 6.7 10.8
DJIA 30 19.1 8.9 -31.9 22.7 14.1 8.4 8.4 4.4 6.1 10.8
S&P 500 15.8 5.5 -37.0 26.5 15.1 2.1 2.1 2.4 5.0 9.6

You’ll note that 2008, although falling somewhat in line with the S&P 500, was a very tough year for the Dogs. And 2009 substantially lagged both the DJIA 30 and the S&P 500. As a matter of fact, after digging way back into my records (you’ll be able to view all of that in Part Two of this subject coming next month – 1972 and forward) I found that 2008 was the worst year for the Dogs – ever, and by far.

Having now presented that little table I want to make a few comments that are critical for an investor to understand as relates to the available sources for discovering performance statistics.

First, the data itself seems flawed if you give it deeper examination. I’ve already said that, according to the footnote that accompany most sources, dividends aren’t always included in the return figures. That then leaves out a substantial portion of the return an actual investor would get if following the process.

But more to the point, the performance stats that are found on the DogsOfTheDown.com website I’ve referenced, contradict themselves. For example, one table they provide shows returns for the years 2006 – 2011 along with average annual returns for 1, 3, 5, 10, and 20 years. The Dow Dog return for 2006 is shown as being 30.3%, for 2007 shows 2.2%, for 2008 shows (-38.8%), etc. But when you pull up the table for each individual year you get a different result. For 2006 these tables show 2006 at 24.8% (vs. 30.3%), 2007 shows a negative -1.4% (vs. a positive 2.2%), and 2008 shows a negative -41.6% (vs. negative -38.8%). This difference in quoted returns holds true across all years in which they have a report. And for the life of me I can’t understand that.

At first I thought that perhaps dividends were being applied in one case and not in the other. But both tables have the same footnote that reads ” .. % change figures do not include for dividends, commissions, or taxes.” So the idea of the dividends being reflected in one and not in the other would seem not to be true. Unfortunately, the site doesn’t offer readers an easy way to communicate with them and ask questions. Believe me, I’ve tried. I’m still waiting for a reply.

The point is this: use those return figures only as a loose estimate of what results an investor would have actually gotten if following the strategy strictly as dictated. If I am ever able to get this question answered, or find a site that gives accurate figures that includes the dividends, I’ll let everyone know.

My suggestion for what to do to make these return calculations available is simple: track your own portfolio. Set up – as I have – a model portfolio on whatever site you prefer (I use Seeking Alpha’s portfolio tracking system). You can use either your actual number of shares owned for each of the ten stocks, the price you paid per share, etc. Or you could select the ten stocks for the year you are working with, pretend you put, say, $5000 into each priced at the closing ask price on the last business day of the previous year, enter the number of shares that you would have bought. Forget fractional shares – round down to allow for some slack that will provide commission cost coverage, and let that track results. At the end of the year, look up the dividends that were paid to you for the entire portfolio and add this dollar amount to the total portfolio value. This then should give you a very accurate picture of what happened for you, individually, over the year’s period. Finding results on the DJIA 30 and the S&P 500 is easily done in many places for comparison purposes.

I know this is a less-than-perfect answer as to tracking and evaluation. But until I – or you, if you know of any – can find accurate and reliable reporting data it will have to do. I rest easy enough with it due to the fact that I can see far back into history and am comfortable in knowing that the Dow Dogs have managed to outperform the broader markets when viewed for longer periods of time.

The Dogs of the Dow offers no guarantee whatsoever of always providing a positive total return for any given year. This is, must, be thought of as a long-term investment whose benefits can only be realized by staying the course for a minimum of 10 years in my opinion. You might do well in shorter time frames or you might not. Like any investment process, the longer you allow it to work for you the better the odds are that you will achieve the goal of increasing wealth. Short-term investors, this is not for you.

As for me, I maintain this process as one of the four investment accounts I run for myself. Typically it represents about 15% of the overall value of all portfolios combined. I have no plans to change that going forward. At present I have the account set up to use dividends when paid to reinvest in additional shares of the company that paid them. Until I need or want the income they produce I will continue this automatic reinvestment. Of course, in the year after the year in which I turn age 70 1/2, I’ll be into that area where the IRS requires I make minimum distributions and pay taxes on those. I have about five years before that will kick in, so for now this will continue as is.

Why do I have the faith in this system of investing to the point where I use it, even though I have sufficient knowledge and experience to make investment decisions in an individual manner? There are many reasons. A few are as follows:

  1. It forces me to buy and hold some positions based on the idea that being a contrarian is a good way to help me with the “Buy Low, Sell High” axiom.
  2. It provides me a way to generate a very healthy level of dividend income, one that tends to grow over time. In 2013, for example, 8 of the 10 positions gave me a raise by increasing the dividend they pay. Only Intel and Verizon did not increase their dividend.
  3. I get a certain level of comfort in knowing that the positions in this portfolio are companies which are stalwarts of the American economy, representatives of the biggest and best of our nation’s economic might. I know them, I use many of their products, and I have faith that, even though they probably are going through some sort of difficulty at present (that’s how they came onto the list) I believe that they will turn that ship around in the future and grow (that’s how they get removed from the list).
  4. I can use this portfolio as a way to objectively measure my own stock picking abilities by direct contrast of yearly returns between the portfolios. It keeps me honest with myself in a way nothing else can.
  5. Most important, it does the job it is designed to do. Over time it has proven to be one way to get better returns than the DJIA 30 gives. This will not always be the case each and every year to be sure. But it has been true more often than not, and that’s all I can ask.

I think this information and commentary is enough for now to get an investor who may be suitable for equity investing started on the path to discovery of whether or not it could work for them. But I have much more to tell you and will do so next month in part two of this story. I’ll be getting way down in the weeds and sharing with you a lot about what I discovered once I got clients involved in this process, things that you won’t find discussed anywhere else as far as I know. You will, I think, find these coming comments instructive and helpful should you decide to allocate a part of your investment dollars to this portfolio. As I said at the start of this column, “Nothing is as easy as it looks. Everything takes longer than you think. And if anything can go wrong, it will, and at the worst possible moment.”

Until then, may the best of results find their way into your accounts, and fair skies sail overhead.

Jim Skelton, The Blind Squirrel.

DISCLOSURE: I am long GE, INTC, and VZ as well as all other of the ten stocks that compromised the Dogs of the Dow portfolio as of January 2, 2014. I will not engage in any transactions in these positions for at least 72 hours after the publication of this article. I am not affiliated with or compensated by any firm or website mentioned in this article. The mention of their sites is intended for the reader to have access to information only and not to promote the website per se. I am not responsible for the information presented on those or any other websites and make no representation as to their accuracy.


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54 Comments on " Dogs Are A Man’s Best Friend: Part 1 of The Dogs of the Dow"

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hipockets
Irregular
1001
April 30, 2014 1:54 am

Great topic, and very informative, Blind Squirrel ! Thank you.

Looking forward to Part 2.

ectopicbrain
Irregular
37
ectopicbrain
April 30, 2014 2:16 am

Thanks.. I always wondered what the theory was. Now I know. It may not be for me but it sure sounds like a good practice for a young, starting investor.

farhangp
Member
1
farhangp
April 30, 2014 3:46 am
thanks very much. Apreciated a great deal. I had read about it as well as many other such systems in The motley fool as you mentioned and believe in them. However, 1) the same information could have been transmitted with much fewer words and saved us busy investors some time! Question: in your long ilustrious career did you not yourself try or know of anyone else who used this dogs theory and made relevant twitches to improve the performance using either some further fundamental or technical factors? I have seen tremendous improvement using in combination moving averages, hirsch,s seasonal factors… Read more »
hipockets
Irregular
1001
April 30, 2014 4:00 pm
Farhang – post 3 I, too, wondered about combining technical indicators, such as moving averages, with the theory. I think that doing so, however, would interfere with the simplicity of the theory for inexperienced or time-constrained investors. Maybe the Squirrel will cover the possibility for experienced investors in Part 2 I also wonder about the inverse of the theory – shorting the lowest 10 yielding. Calling that possibility the “Cats of the Dow Theory” would be the purrfect name. Jim, I like your writing style. It’s always nice to get “behind the scenes” information.
JDC
Guest
0
JDC
April 30, 2014 6:44 am

follow

captron
Member
0
captron
April 30, 2014 7:20 am
Thanks Jim, great article. When my son was 16 (1998 or so) I introduced him to the dogs via the motley Fool – and also had him read “The Richest Man in Babylon”, and so began his investing career. The dogs at the time (only 5 stocks I think per the fool) included GM and GT and the theory was in the midst of a dry spell as I recall. He didn’t stick with the dogs but he did stick with investing and the Fool and I have to admit I now ask him for advice which I sometimes wish… Read more »
vivianlewis
Member
167
vivianlewis
April 30, 2014 9:17 am

bow wow
dogs of the Dow

hedy1234
Irregular
420
hedy1234
April 30, 2014 9:19 am

Follow

carlb60
Irregular
24
April 30, 2014 12:14 pm
As usual a great article. Your comments RE discrepancy between (Web) published numbers and actual – with or without dividends – are one of the most important points you make. I subscribe to Ycharts.com and recently subscribed to Zacks.com for a cross check. Even tho I have no restrictions on my “screeners” as to size or exchange, and even tho both services return about 2,850 issues to my screens (latest Zacks = 2,995 Ycharts = 2,776), on average only 65% of the stocks appear on both lists. Also, while the factors I screen for are usually pretty close to the… Read more »
hipockets
Irregular
1001
April 30, 2014 4:20 pm

You can also check Yahoo —
Intraday market cap of BACHY is 122 billion
http://finance.yahoo.com/q/ks?s=BACHY+Key+Statistics

For many stocks, you can check NASDAQ (not jut NASDAQ stocks), but BACHY is not listed.

carlb60
Irregular
24
April 30, 2014 12:17 pm

Oops: I think those market cap figures for BACHY are $ Billions not $ Millions.

justirregular
Member
72
April 30, 2014 12:53 pm

Jim, Great articles. Thanks…I could really use the informtation and I am already sliding down the hill of trading! So is my portfolio! Ha, keep up the good work! Thanks again!

Thane Walton
Guest
0
Thane Walton
April 30, 2014 3:16 pm

I’m trying to buy into the notion that I am a reformed risk taking, news watching junkie. If I am truly to reform, I need to do more stuff like Dogs of the Dow and follow the advice of smart people like Carl Richards (www.behaviorgap.com). I’ve lost too much money over the years taking risks in high flyers and dabbling in options. Somebody save me!

Guy Finley
Guest
0
Guy Finley
April 30, 2014 5:01 pm

Just wanted to say thanks, and have meant to do so, for a long time now. I always enjoy reading the articles, and have — from time to time — been moved to buy, as a result.

If you have the time and interest…would love to know what company is being touted by Stansbury as the next “Royal Gold”.
Thanks, for your efforts.
GF

Travis Johnson, Stock Gumshoe
Admin
4822
April 30, 2014 5:22 pm

That’s Altius, I just moved that article to the top of the home page because lots of folks are asking.

William Douglas
Guest
0
William Douglas
April 30, 2014 5:13 pm

Jim, Great article. I am going to bookmark it. Just one question though and not trying to be a nit picker but at the very end of the article did you mean the stocks that comprised the DOTD as opposed to compromised. (Sorry it’s the English major in me).

eddie036
Irregular
1
eddie036
April 30, 2014 6:02 pm

followup

sham_rock
Member
0
April 30, 2014 10:51 pm

Dear Squirrel,
The Peter principal refers to a person “rising to their level of incompetence”. Murphey’s Law is what you described.

Rusty Brown in Canada
Guest
0
Rusty Brown in Canada
May 5, 2014 8:19 am

Agreed. But it’s “Peter Principle”, not “Principal”. And “Murphy’s Law”. Not “Murphey’s”.
Just for the record.
I had the misfortune to work for a supervisor who was an excellent programmer so was promoted to supervisor to give him a bigger paycheque. But he avoided dealing with people (i.e. myself) and spent his days staring at his screen and doing programming, leaving me – and others – high and dry when it came to support.
Classic case of “The Peter Principle”.

jomcintyre
Irregular
154
jomcintyre
May 1, 2014 1:14 am
Thanks for this comment, W. Douglas. I had the same thought, but have already done my complaining/correcting of blog posts for today. RE: Dogs of the Dow. I was first introduced to the concept by Louis Rukeyser and have been grateful ever since. My only alteration to the theory was to avoid getting companies I didn’t like for other reasons. I ended up getting shares in about 5 to 7 companies. You’re so right about the dividend income stream! That’s one reason I have moved recently to a more Dividend Aristocrat model. Some recent dividend increases have been phenomenal! I,… Read more »
Dave H.
Guest
0
Dave H.
May 1, 2014 11:14 pm

” If I am ever able to get this question answered, or find a site that gives accurate figures that includes the dividends, I’ll let everyone know.”

Stock (and mutual fund) prices with all dividends reinvested in the same stock or mutual fund are available from the data service at http://www.fasttrack.net.

hipockets
Irregular
1001
May 2, 2014 5:58 pm

Dave H.–Many thanks for the link. Great site, and much of the information is free.

Dave H.
Guest
0
Dave H.
May 2, 2014 8:25 pm

I have subscribed to Fasttrack’s data since 1998. They usually get dividends applied on the same day they go ex-div or almost always within a day or two later. If you are doing testing of trading system, their data is the best way to do realistic testing.

Dave

The Blind DayTrader
Guest
0
The Blind DayTrader
May 2, 2014 3:08 am
Jim, I know this is not the option topic, but maybe it’s worth asking here: would it be reasonable to sell covered calls on the shares held in this theory? Would that not up the returns, without compromising the nature of the theory by “rolling your own” as you discussed in another post? I have trouble seeing any downside to doing that. 1. If the stock rises and it is called away, you can just immediately re-buy, with an altered cost basis. No tax penalty because of the wash-sale rule. 2. If a stock declines, your calls expire, and you… Read more »
bfchmv
Irregular
13
May 4, 2014 3:52 pm
Changing the subject: The Oxford Club is running an old teaser they have used before about “Saving America” and the 6 huge companies that are investing 1.2 trillion to do so. They are referring to natural gas and the distribution of it as well as converting our present cars over to it and even individual home refueling stations. Would you please reprint your answer to their expensive teaser and give the symbols for the 6 companies? Or tell me where I can find the info in the archives. Thanks. I love this websita! Marilyn Scott
Margaret Kittelson
Guest
0
May 4, 2014 6:48 pm
Blind Squirrel – For years, I’ve not thought about dividends. You drew me into taking a look-see and recognizing their add-on value. That value did quite surprise me! You also drew me into my past…when I had no access to research of stock possibilities. Every day I examined newspaper listings, looking for stocks that made a good percentage gain. I then called a broker and ordered purchase of shares in some symbol, while not even knowing the name of the company or anything at all about it. The internet, and on-line brokerages, revolutionized investing. You gave me such a nice… Read more »
bkkben
Member
8
May 5, 2014 3:47 am

Blind Day Trader; the main risk I see with your plan of selling covered calls on Dogs of Dow is that a spike in any of the stocks over the mont ,say from $48 to $60 on great earnings – with a covered call sold at say $50 for a 1% extra income(premium) would have you selling the stock at $50 and having to re-enter at $60 for a 19% “loss” (lost upside).

Yes; you could technically roll the calls forward but they will be priced accordingly so a opportunity cost right there still.

Cheers!

dgcannon
Member
27
May 5, 2014 9:29 pm

Jim,
Thanks for your suggestion on a high yield stock. I tend to buy lower-priced stocks
because they often have lower PE ratios, and with more shares there is some
possibility of appreciation. Also, not so much downside.

big dimmy
Guest
0
big dimmy
March 31, 2015 12:17 pm
Hi Jim: Hi! After 20 years, and all the ups & downs of the Dow and also the Dogs strategy …. they end up in a dead heat? A photo finish. Can this be true? Hmm. The past is no guarantee of the future, OK; but what was gained by going with the Dogs, when it simply duplicated the Dow returns after 20 (!) years. and what can we looked forward to as this point, based on our long-term 20 years of experience. PS: OK, i realize, there may been a differential based on yield & dividend payouts. Many thanks.
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