[Ed. Note: Jim Skelton, The Blind Squirrel, writes a monthly column for us about his experience as a Financial Advisor. His topics, thoughts and opinions are his own. Enjoy!]
Greetings once again to the Gumshoe Nation! Your resident Blind Squirrel returning for June with what will be the last posting regarding the Dogs of the Dow theory of investment management. In this month’s column I am going to explore a couple variants of the process that have been more or less accepted by the general investment community as viable alternatives to the basic strategy. Variations that stay true to the underlying philosophy of buying and managing the portfolio based on yield and rebalancing once yearly, but alter a couple of the other parts of the approach in hopes of getting even better results.
Before I began that part of the discussion, I’d like to refer any new readers back to the previous two parts of this series for review. Since my columns are viewable by all visitors to the Stock Gumshoe site, you may be just now dropping by to see what’s on tap here and not have seen the previous posts on the subject of the Dogs of the Dow investment strategy and process. If that’s you, and you care to, you can see Part 1 of the series entitled “Dogs Are A Man’s Best Friend,” here. In this section you are given a historical overview of how this strategy came into being, some of the past results using it have provided, and a working base of information as to how to go about setting up an account for yourself that utilizes the strategy. Then, in Part 2, “Getting Down To Business,” you are given specific instruction on how to select the stocks for the portfolio, why investors seem to be attracted to the process, some of the psychology behind the strategy, an example of what not to do based on an actual case I had with a client in the early 1990’s, and the very important process involved in the yearly rebalancing of the portfolio. Also included in that report is a link you can open and view the actual marketing brochure I wrote (with compliance approvals) and used to present the idea to clients when I was working as an active Investment Advisor. It contains, among other things, a historical chart of performance going all the way back to 1972 – data I seriously doubt you’ll find anywhere else at all. It can be useful information for devotees of the Dow Dogs Theory. To view Part 2, click here.
That will serve to get you up to speed and ready to understand more fully what I will address today in this final part of the series, ”There Is More Than One Way To Skin A Cat – Or Dog.”
Let’s get down to business.
We humans are a curious lot. Seems we are always striving to take things one step further in an attempt to improve on whatever it may be we are looking at. And that is a very, very good thing. It’s called ”progress” and without that we’d all still be stuck thinking that the world was flat, nothing could ever replace the horse as transportation, or cooking on a spit over an open flame was the ultimate in kitchen technology. So we tinker, we alter, we ask ”what if?” And this has applied in spades to the Dogs of the Dow theory over the past 25 years or so. I’ve seen more variations on how to ”improve” the returns, or reduce the risk, or apply better standards of selection, than I can remember. Dozens, literally. But at the end of the day they all go perhaps a bridge too far and never gain any traction within the investment community overall. Something may work for the person that came up with the idea, but it has something in it, something that others just aren’t willing or capable to do, in order to run the portfolio. They seem always to take what is a basically simple process and make it complicated. We don’t like complicated as a general rule. I know I don’t. The original formula for selecting the stocks we’d own, the way we ”manage” them over the course of a year, and the method we use (here again, a simple method), to make buy/sell decisions and rebalance the portfolio has never been bested in my opinion. And that is why I stick to the original flavor. See, I’m a ”Coke Classic” kind of guy. ”New Coke” just doesn’t cut it for me.
That said, there is one – only one – variation on the original concept that has taken root and is quite popular with investors. It actually makes things even simpler than the original process while retaining all the basic underlying tenants that we use. It is the only variant I ever used with a few select clients and the only one I would consider for myself. It’s known as the ”Small Dogs” approach, and here’s how it works.
The Small Dogs
”Winning isn’t about the size of the dog in the fight. It’s about the size of the fight in the dog.”
I first encountered this concept sometime around 1995 or so. And unlike other variations on the original strategy, it caught my attention for one basic reason – it stayed true to the methodology employed in the original approach to stock selection, maintenance, and yearly realignment. Everything else I had seen changed some part of that. But all the ”Small Dog” strategy changed was the number of stocks in the portfolio. Instead of holding 10 positions, the Small Dogs holds only 5. And the way those 5 are picked from the original list of 10 is simplicity itself: one just looks at the share price of all 10, then culls out the 5 with the ”smallest” (lowest) current price. That’s it. Done. The investor decides how much total cash they want to fund the account with and spreads that evenly over these 5 stocks. At the yearly adjustment time, the new list of the top 10 yielding stocks in the DJIA is compiled, then the 5 with the lowest share price are used for adjustment to the Small Dog portfolio.
The only quirk here is that you might have bought a stock in the original Small Dogs portfolio that is still on the Top Ten list, but has since appreciated to a point where it isn’t one of the 5 lowest priced stocks on that master list. It may still be on that Master List, yes. But you will sell because it isn’t one of the 5 lowest priced. See the difference? Still on the main list but no longer something you would keep in the Small Dog portfolio. But no matter – it works out fine.
Over the years the Small Dogs portfolio has been able, in many instances, to perform a little better that the original Dogs of the Dow. But not always. Let’s look at the first half of 2014 as example.
I maintain hypothetical tracking portfolios on another financial site to stay in touch with performance of several different portfolios. Two of these portfolios are the original Dogs of the Dow stocks and another is for the Small Dogs portfolio. In theory, I place $10,000 in each portfolio on January 2nd of each year. That’s $1000 for each of the original Dogs of the Dow portfolio stocks, and $2000 for each of the Small Dog positions. Both portfolios therefore start each year worth $10,000. Then I let those dogs run just as I would if these were actual portfolios. This gives me an accurate picture of how the portfolio is performing at any given time. I can use that data to make direct comparison between benchmarks and other portfolios. The only thing that my system cannot account for is dividends – and that is an important part of the total return on these Dogs portfolios. So I compensate by looking at the yield based on entry price and last declared quarterly dividend, then do a simple calculation to get an average yield figure. This I then use to calculate approximately how much income the portfolio would have generated year-to-date, and I add that back to the portfolio value to arrive at an approximate return percentage. It’s not a perfect system, I know. But close enough for this work.
On January 2nd, 2014, the 5 stocks that made up the Small Dogs portfolio were Cisco (CSCO) @ $22.17, General Electric (GE) @ $27.86, Intel (INTC) @ $25.78, Pfizer (PFE) @ $30.47, and ATT (T) @ $35.24. In fact, those same 5 stocks are still the 5 low priced stocks on the Dogs of the Dow Top Ten list.
As of June 25, 2014, the Small Dogs portfolio was valued at $10.482, up 4.81% not including dividends. The Original Dogs of the Dow portfolio was valued at $10.816, up 8.16% not including dividends. The average dividend yield for the Dogs of the Dow portfolio on January 2, 2014 was 3.44%. Divide that by half to account for 2 quarters of payments and you have 1.72%. Multiply 1.72% by the $10,000 investment and you have income of ~$172 to add to the return. This would then give you a value of $10,654 (6.54% total return) for the Small Dogs and $10,988 (9.88% total return) for the Dogs of the Dow original portfolio.
As I said, I know this is an imperfect calculation for the total return including dividends. But it is close enough to let us evaluate the relative returns of the two portfolios against one another and the appropriate benchmark of the DJIA 30. For the first half of 2014, the Small Dogs are doing quite nicely, but the Dogs of the Dow Top Ten are taking names and kicking butt. Year to date, the DJIA is up 1.46 % – it began the year at 16,576 and closed today (6/25) at 16,818. Relative to that, both portfolios would have to be thought of as performing extremely well!
Do The Small Dogs Win The Fight?
The best answer to this important question is … maybe. There are years when they beat the original Top Ten, and years when they don’t. And importantly, there are years when the market is down that they substantially underperform to the down side as shown under the year 2008 below. That means more risk of loss, never a good thing. An investor needs to take that into consideration when evaluating the idea of using the Small Dogs approach. Consider the following table of returns from the website DogsOfTheDow.com:
Average Annual Return Investment
2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 1 yr | 3 yr | 5 yr | 10 yr | 20 yr | |
Dogs of the Dow | 30.3% | 2.2% | -38.8% | 16.9% | 20.5% | 16.3% | 16.3% | 17.9% | 3.4% | 6.7% | 10.8% |
Small Dogs | 42.0% | 4.2% | -49.1% | 19.3% | 15.4% | 19.2% | 19.2% | 18.0% | 1.8% | 7.7% | 12.5% |
Why would this be so, I wonder? This is a question I’ve never been able to answer to my own satisfaction. Some say it’s the result of that widely-held belief that contends the lower the price of a stock, the easier it is for the price to rise faster and further than more expensive ones. And I have to admit that at times this does seem to be the case. But this isn’t supported by rational and logical thought. Stock prices should rise or fall based on the underlying fundamentals such as earnings, P/E ratios, revenue growth, etc. Perhaps it is due to that low price finding a way forward faster than one higher priced. When all is said and done, it really doesn’t matter why – the Small Dogs have the advantage over longer periods of investment.
The website does not have results posted for 2012 or 2013, but this is a good enough sample for us to gain insight. The Small Dogs have a better record at times and a worse one at others. Long term, the Small Dogs have the advantage with a 20 year average annual total return of 12.5% vs. 10.8% for the Top Ten.
Other than this ”Small Dog” variation of the strategy, I really don’t have any other approach that I want to delve into at this time. It would just confuse the issue. If you have a variation that you can demonstrate generates superior returns and can be verified by means of back testing, and is relatively simple to implement, I, and I’m sure other readers, would like to hear from you about it. That’s one of the true beauties of the Stock Gumshoe website – the ability for readers, Irregulars (paid members) or not, to respond and communicate directly with the columnists here and get responses, not only from them but from other investors that are also interested. Try that on any other site. I doubt you’ll find a more user-friendly financial site anywhere.
If I may say so once again, Stock Gumshoe is truly a one-of-a-kind place for investors to gain all sorts of knowledge and information, and exchange same freely with one another in a respectful manner. Consider that, and become a site member, an ”Irregular” as the Chief-Gumshoe-in-Charge, Travis Johnson (site founder and CEO), calls them. It’s only $49 bucks a year – and what Travis alone shares on a near-daily basis by ”un-teasing” the ideas other financial newsletter publishers send out and then want you to pay hundreds, indeed at times thousands, of dollars to learn what stock they are recommending. Travis uses his ”Mighty, Mighty Thinkolator” to uncover the identity of the stock and then provides a thoughtful and in-depth overview of the company to boot. It must make those guys and gals at places such as the Motley Fool, Stansbury & Assoc., et al, totally nuts to see their ideas being so easily and accurately revealed. And at no cost or obligation on the part of our readers. Pretty astounding when you think about it!
Note – No, I’m not paid to say that. Not a penny. Never even been asked to express my thoughts on the subject. It’s just that I happen to be one of those people who, when he finds something of true worth and value, likes to share the idea with others and isn’t shy about doing so. This site fits that bill. Consider yourself as having just been shared :0)! Now, when done reading this article, find the place on the home page where you can get signed up as an Irregular and JUST. DO. IT.
"reveal" emails? If not,
just click here...
[Ed. Note: Aw, shucks, thanks, Jim. Well, if you insist…free members can upgrade here.]
Better get back on track now before I wander too far afield from the subject at hand. I’m prone to those little asides on occasion. Let’s see here, where was I … ?
Oh Yeah – The Dogs of the Dow portfolio strategies and related matters.
ETF’S, ETN’S, and Other Ways to Invest In The Strategy
At this point in the discussion I’m going to segue from talking about variations in the strategy itself and into a look at some of the different ways you can choose among to get the strategy up and running for yourself.
I’m going to assume you already know what an ETF (Exchange Traded Fund) and ETN (Exchange Traded Note) are. But in case you aren’t sure, they are portfolios made available for investment by various brokerage houses that contain a specific set of investments geared toward a particular area of investing. These selected positions, which can be equities, debt instruments, or hybrids of these, are wrapped into the ETF/ETN and trade daily on the exchanges just like a single stock. You can buy or sell at any moment at the current bid/ask price. And there are quite a few that are available that contain the Dogs of the Dow stocks and in general operate under the rules of the strategy. An investor who wants exposure to this portfolio with even less effort can simply buy shares of the ETF and let the managers take care of all else.
But there is a price to be paid for all this convenience. In addition to whatever sales commission your broker charges, there are internal management fees that are assessed against the portfolio. These generally run between 0.35% to 1.00% annually. That cuts into and reduces your return. Over time this can add up to more than what a little number like those seem to represent. Also, the investor doesn’t have total control of the portfolio as they do if they own the individual stocks and run it for themselves. If it should happen that one of the portfolio positions is well and truly going into the tank and ought be cut loose before a bad situation could get a lot worse (for example, a major reduction in the dividend, or being taken out of the DJIA by the people at Dow Jones & Company that are responsible for making those periodic adjustments) the investor in the ETF has only one choice, and it’s not a good one. She must either hold on and ride that storm, or sell everything and close the entire investment. The proverbial rock and a hard place decision, so to speak. The investor that has his account set up and is holding the individual stocks can zero in on the problem child and shed it alone, leaving the rest in place and intact. A much better choice to have, wouldn’t you agree?
With that said, a reminder: Making adjustments to the portfolio outside the ones called for by the strategy is not recommended. In the 20 some years I used the process with clients, there were only two instances I felt were of serious enough potential consequence to warrant stepping in and making a change. Resist the urge to do that, to make changes based on some new report or unfavorable news. Take the emotion out of the equation and let the process work as it is supposed to do.
Now, I know you are curious as to what those two situations were that caused me to get on the phone with clients and recommend making a change that didn’t align with the strategy. So I’ll tell you about one in detail, the other in general. That way you will see what I mean when I say the situation must be dire, not simply unsettling.
The first case happened in late 1992 as best I recall. I had been using the Dogs of the Dow strategy with clients for about a year and had maybe one dozen or so accounts established. The list of stocks in the top ten was headed by a company called Woolworth’s, an old-line retailer commonly referred to as a ”five and dime” store. That came from the idea that most goods sold there when the stores were first opening in the late 1890’s and early 1900’s cost from a nickel to a dime. These were ”sundry” or ”notions” stores where a housewife could get most anything she needed to keep the household running smoothly, especially in the areas of bolt cloths and all the things needed to make and repair the family’s clothing. After 100 or so years of operations, these stores (J.J. Newberry was the other main player still standing in that space) were under tremendous pressure by the likes of Sears, J.C. Penny, and that upstart company out of Arkansas, Wal-Mart, to change or die. And they seemed incapable of change.
Woolworths was the number one company on the top ten list due to a nice dividend and a serious decline in price over the previous year or so. Quite frankly, I didn’t like the idea of owning the company at any price, but following the discipline of the Dogs I had no choice. So all clients owned it as a part of the portfolio. One fine morning I walked into the office, took my seat and opened my WSJ to see a bold headline that announced Woolworth’s board had met the previous evening and cut the dividend by 50%! Oh boy. What a way to start the day. A cut of maybe 10% is cause for concern – but a cut of 50%? That goes way past mere concern. That gets into fire drill territory.
I sat and absorbed the impact I knew would happen to the stock price when the market opened at 10:00 AM, a couple hours yet away. I remembered a study I had seen some years before that looked at the impact a dividend cut had on stock price, and also on the likelihood of additional cuts. I remembered that this study concluded by saying a cut of over 25% was in all probability precursor to additional cuts coming soon. Which could only mean additional declines in stock price. I had a decision to make. An important one, not just for the sake of perhaps stopping the possibility of future price declines in Woolworth’s stock, but for how I would manage these Dog portfolios in the future and the impact that could have on my own commitment and credibility with clients. Remember, I had come down hard on the idea of a ”hands off” approach to the portfolio during the time between the annual rebalancing. And I was now pondering violating that concept myself. What would that say to clients, what would it do to their commitment to the system if they got concerned about a company they owned and wanted to get out?
After maybe 15 minutes of checking all other news sources I had access to and thinking over my choices, I decided this was an instance where being proactive was justified. I began to call clients that were using the strategy, telling them what had happened, and asking they allow me to sell their shares on the open. Each and every one gave me that permissions, so at 10:00 am the tickets were all dropped and the sales were made. It wasn’t pretty – but we were out. The proceeds were used to buy whatever stock had been in the number 11 slot at that time.
A quarter passed, the stock price fumbled and bumbled around, never improving, and the board met again. This time, they did just what I was afraid they might have to do – they totally eliminated the dividend. Share price tanked, of course, and Woolworth’s was down for the count. All that remained was for someone to write the eulogy and bury that blast from the past. It’s change and adapt, or die in Capitalistic economies. Woolworth’s was unable to change. So they died.
I’m not proposing any sort of genius on my part in this decision. Yes, it saved clients some money to be sure. But I would have much rather it never happened so I didn’t have to violate the way the strategy is supposed to operate. I vowed to always be as totally sure as I could be that a change was absolutely necessary before making those kind of calls to clients again.
The only other time I had to make a decisions was when the Board of Directors at Dow Jones & Company made some changes to the composition of the DJIA, and in so doing dropped from the index one of the stocks we held. I decided it best to go ahead and sell that company – we’d be doing it at rebalancing time anyway – and replace with the next stock that fit the requirements. Not a big deal, really. But it was the last time I ever made a change to the portfolios based on what I thought was best instead of just letting the story play out as proscribed. I tell you these two little stories to emphasize the level of commitment you need to have to stay the course and not interfere with the process.
Now back to the discussion of using ETF’s and such.
I covered all the disadvantages that I see in using the ETF format as the vehicle of choice in Part 1 and Part 2 of this series, so I’m not going to ride that horse again. You should know by now I am a committed and dedicated proponent of owning the individual stocks outright. Even so, I know there are some who, due to time constraints, knowledge, or basic disinterest in the process, still seek that total simplicity the ETF offers, and who am I to say what is right for you? That said, here’s one example of an ETN for you to consider. Note: this is not a recommendation or endorsement by me of this particular ETN. It’s just one that I’ve seen referred several times in other venues and have some current research available and at hand.
Elements Dogs Of The Dow Total Return Index Note (DOD)
DOD is an Exchange Traded Note that follows the Dogs of the Dow investment strategy. It’s stated investment objective is: ”The investment seeks to replicate, net of expenses, the Dow Jones High Yield Select 10 Total Return Index. The Index tracks the stocks with the highest dividend yield in Dow Jones Industrial Average.” It has a net expense ratio of 0.75%As of June 25, 2014, the last 52-week price performance was +19.70% and the closing price was $14.92 per share. For the 5 years ending April 25, 2014, the cumulative total return (including dividends) of DOD was 183.3% vs. a total return for the SPDR S&P 500 (SPY) ETF of 138.1%. A rather sound trouncing of the benchmark for this time frame.
Note must be made of the fact that ETN’s have both a NAV (Net Asset Value), which is the true value of the underlying positions in the portfolio, and the actual trading price. These two valuations can and do differ in relation to one another. The NAV of DOD was $14.91 on June 25, 2014 vs. the closing price of $14.92 per share. Net assets under management as of April 30, 2014 (the last date this number was reported) was $26.2M. Inception date is November 07, 2007. The ETN is sponsored by Deutsche Bank AG / ELEMENTS ETN’s and has the legal structure of being a Senior, Unsecured, Unsubordinated Debt instrument.
Unfortunately, certain data points that I would like to know are not given in the available research. For example, under Distribution Yield there is no entry. No list of the basket holdings is shown so I can’t be sure exactly which stocks are held. Under the heading of ”Annual Turnover Ratio” the entry reads ”0”. This would imply no trades being made within the portfolio, which leads to questions about rebalancing and following the Dow Dogs buy/sell discipline. So many questions, so little information. And under the heading ”Investment Philosophy” the entry reads simply ”Enhanced Strategy.” What, exactly, is meant by ”Enhanced?” I know it is not a leveraged portfolio, nor does it use options of any type. So what is this reference to being ”enhanced?” One wonders – and I’d have to know with more certainty before I, personally, would be willing to commit my cash to it. Perhaps the prospectus, something I do not have at hand, would shed more light on these questions.
Source: Fidelity Investments Research Key Statistics and MarketWatch article released May 5, 2014, entitled ”Hot ’dividend dogs’ take world stocks by the tail.”
I could continue here, building you a long list of similar ETF’s from differing Sponsors. Seems to me that this would be an unending process with no particular benefit. If you want to use this ETF format as your vehicle of choice, just go to your brokerage firm’s research hub and enter something like ”Dogs of the Dow ETF’s.” That should get you a list of the products they offer for you to choose from. Just don’t expect there to be much difference one from another. If they are staying true to the strategy and not employing leverage, options, or other techniques to try and improve returns, there is little reason beyond internal management fees for the results to differ by much. If you do run across one that has substantially better net returns, look carefully before you leap. There has to be a reason for this outperformance, and that reason may translate into not only a better total return number but also a much higher risk factor. Mr. Market does not provide us free lunches.
In case you may be wondering if there is a mutual fund that employs the Dogs of the Dow process, the answer is no. There can’t be. By definition, a mutual fund offers investors a certain level of diversification to potentially reduce risk somewhat. The SEC set a minimum limit of 30 positions that a portfolio must contain in order to qualify as a mutual fund. And since the Dogs of the Dow has only 10 positions, it could never be classified and used as a mutual fund offering. I have seen a couple variable annuities that offered the Dogs of the Dow strategy as an investment option within the annuity. Given the additional complexities of annuities in general, I normally don’t think of them as being a way to use the process. But that depends on the needs and wants of each individual investor, so I suppose it could be used if suitable and appropriate.
Summing Up – Are Dogs Really A Man’s (Or Woman’s) Best Friend?
I suspect it is more than apparent by now, I am a believer in the Dogs of the Dow investment strategy as one way to manage a part of an overall investment program. Note I say ”a part of”, not ”all of.” That is a key takeaway from these past three articles on the subject. The Dogs gives an investor a logical and disciplined way to manage a portfolio of large cap value stocks. It forces him to use the contrarian approach to buying – going against current conventional wisdom, not running with the crowd. And, unlike many other approaches, it not only tells you what to buy and when, it also has a disciplined structure for when and what to sell – a key ingredient that is often lacking in other methods. Several legendary investors such as Sir John Templeton trumpeted this method of investing – contrarian investing, that is – not the Dogs of the Dow specifically – with great success. It takes patience and discipline to follow, but the rewards can be bountiful. When used as part of a mix that could also include growth stocks, momentum stocks, and high-income instruments, it can provide a certain balance within the overall portfolio and help smooth out the ride over time.
So are dogs a man’s best friend? To my mind, yes, they are. Now it’s your turn to decide. Could adding this into your mix prove beneficial? Only you can answer that.
Time now to put a bow on this month’s edition of The Blind Squirrels Diaries, send up to Travis at Gumshoe HQ for his OK, then have his trusty assistant, Lynn (someone you will never hear from but is the person that makes me and other writers here look to be better than we really are with grammar, spelling and such) and then hopefully get published before June becomes July.
And speaking of July, the 4th is just around the corner. I wish all of you a great time on this very special holiday, the day we celebrate our Independence and Freedom. When at a backyard BBQ with friends and family, or tailgating at a sporting event, or just taking it easy for a day, please take a moment to remember our brave men and women serving far from home, providing us with that blanket of protection and preserving those freedoms and liberties we so often take for granted. God bless them one and all and keep them from harm’s way. Remember them, and the many that came before. We owe who we are and all we have to the sacrifices they make every day on our behalf.
Until next time, may the best of investment success come your way, and remember: ”Even a Blind Squirrel finds an acorn every now and then”
Jim Skelton
The Blind Squirrel
Very informative article ………Thank You!
Out of curiosity, how do the sharpe ratios of the Dow, Dogs of the Dow and Small Dogs compare? Despite the increased return of the Dogs and Small dogs, does increased variability hurt the ratio?
George, I can only say you are a more curious fellow than I. It has never even occurred to me that I might check the Sharpe ratios between these three portfolios. In fact, other than to perhaps have an “ah-ha!” moment at finding one looks better than the other in this regard, there would be no point in doing the work. I know that might sound dismissive. It’s not. I respect an inquiring mind. The reason I say this is because it is not a measure by which the “Dogs” portfolios would ever be run or managed. Remember, this is a very simple way to select, hold, and sell a small portfolio. Measuring them via Sharpe ratios, or PEG’s, or P/E, or cash flow or anything you can think of other than dividend/yield won’t change the selection or management. So I’ve never looked at these criteria and applied to the process. To do so would be to violate the basic premise under which they are formed, and therefore destroy any value a historical performance record might show.
Keep it simple .. that’s the way of the Dog.
Its not a way to run or manage the portfolio, but a measure of whether you should invest in it. If the sharpe ratio is poorer, then it would be better to buy the dow or such with leverage to get better returns for the same risk (ex. a combination of leveraged and unleveraged etfs to beat the dogs returns with less/same risk) … or simply select a better investment vehicle. If the dogs consistently have a better sharpe ratio, then its a real dow replacement.
George:
Since you understand that process, could I ask a favor for all of us? Could you run that calculation and report back the results? Perhaps use the DJIA 30 and the S&P 500 as your base comparison? I’d truly like to see how this shakes out.
Great wrap-up, Jim. Thank you. And thanks to the lovely lady Lynn, who keeps everyone up to snuff.
You’re welcome, Hi Pockets. Thanks for saying so. As for Lynn, hands off, Buddy! She’s MINE! :0)
Once again a great article. Just for discussion I call your attention to the latest “Dismal Optimist” (http://thedismaloptimist.com/) letter by Peter Treadway. He acknowledges Sir John Templeton who has said, “the most expensive words in investing are – this time it’s different”. Then Treadway states, “foolhardy though it may be, I am about to assert exactly that, i.e. this time it is different. It is different because the entire world has reached a sort of tipping point whereby technological change is accelerating at a pace not seen before in human history”.
Although I admire Sir John, agree with his philosophy and admire his results, this time I have to cast my vote with Treadway.
What does this have to do with the “Dogs of the Dow”? How does technological change affect the “Dogs of the Dow” method of investing?
Here’s my opinion. Technology now enables a tech savy investor to pick the top yielding stocks from thousands of traded stocks – not just the 30 stocks that make up the DJIA . Our tech savy investor can now pick his or her 10, 20 or 50 top yielding stocks from all stocks that are traded on major exchanges and include valuation factors including price to book, price earnings, market cap, etc. in the selection process.
I have no doubt that the “Dogs of the Dow” works. My father used it and left me a nice inheritance, but a better strategy may be the “Dogs of the Universe”. Whatta you think?
Carl, that’s a thoughtful reply. The merit of it has to first prove itself for me, though. Yes, technology has without a doubt entered the investment arena in ways undreamed of even 10 years ago as well as other aspects of life. And it does seem to us living in these times that this is exceptional. But let’s drift back about 115 years in time and ask yourself how your great-grandfather felt when he saw and heard his first “horseless carriage?” Or the first time your grandfather perhaps 100 years ago saw an airplane with people in it soar overhead? Or 50 years ago when your Dad saw his first wireless, portable telephone so small it fit in a briefcase! :0) The point is that advancing technology always makes the people having to adapt to it feel as if nothing like this has ever happened before and nothing will ever be it’s equal.
For such reasons I cling to the idea that it’s quite possibly foolish to contend that “this time it’s different.” It is different in some way, perhaps – but never different in a fundamental sense over time. I stick with Templeton on this concept. Or maybe like a physics professor might say, “you can bend time, you can warp it – but you can’t eliminate it.”
Now, can we employ this technology to select a different set of high-yield stocks from a tremendous universe of possibilities and get a better result that the Dogs provide? I agree that this might be possible. And if it can be demonstrated by back testing I’m more than ready to know of it. In fact, in my article I referenced another source under the section headed “Elements Dogs of the Dow Total Return Index Note”. The source was a release from Marketwatch dated May 5, 2014, and entitled “Hot ‘Dividend Dogs’ take World Stocks by the Tail.” In that article (wish I could give you a link but don’t have it) they talk about a couple new ETF’s that have been designed using stocks from all over the world and generally applying a selection process similar to the Dogs of the Dow. So this thought is evidently already out there and being explored. What remains to be seen is if these new ETF’s prove successful in besting the normal Dow Dogs. And that will take a number of years – at least 10 to satisfy my criteria to give any meaningful results by which to judge. And those years will have to include periods of growth and decline, a period something akin to 2004 – 2014.
Technology and it’s application to the investment process may lead us to better results. Or it may not. But no matter which way that goes, I’m compelled to add once again here a point, perhaps the single most important point I’ve been trying to make about the Dow Dogs strategy, for consideration. It’s just this: In order for a strategy to work in the real world, for real people, it must be (1) easily understandable, (2) simple to implement, and (3) not consume onerous amounts of time to maintain. So even if a strategy of selection and maintaining proves to give better returns, the vast majority of people will not ever go there. Because the vast majority of people simply do not have the information, the education, the access to platforms and processes, the interest, and the time to devote to a complex approach. We here on this site are prone to forgetting that. We exist in a bubble of sorts. It’s not a put-down. It’s a statement of fact. The people we encounter here are, if I may say so, a bit elite in terms of expertise and investment knowledge – all good things. To expect that of all comers is foolish. My years as an Advisor proved that beyond any doubt. I could have never, ever, gotten such a high rate of participation in a program if the client didn’t understand what we were doing and why.
The Dogs of the Dow allow for that to happen. My question then would be, if a tech-research driven approach can be developed and proven superior, will John Q. Public be able to replicate it for himself? To paraphrase the Angel in “Field of Dreams”, “If you build it, will they come?”
Thanks for your comment, Carl – makes me think. I hope a better way is found someday. Until then, I’ll keep my hard-headed belief that no, this time it isn’t different, and stick with my faithful companions, my best friends, my Dogs of the Dow.
Why not use the adjusted close prices in the Historical Prices section of finance.yahoo.com. I think this is an easier and more accurate way to track the dividends and price appreciation on the five or ten stocks held in the portfolio.
Dan
Dan, that’s a great suggestion! I’ve never done so but will have a look at that. Could be you are on to something useful here. This is why I LOVE this site – the collective gathering of ideas to help all of us improve and expand our investing knowledge. Thanks for you contribution to that process!
Jim; Another great piece. I like simple. You mentioned that there seemed no rational reason for an occurrence,,, I believe the market is irrational,,,,that does not mean that we may not find patterns/cycles in the chaos. If something works,,,don’t argue,,,,use it.
Frank, we are in agreement in many ways here. “The Market”, that collective of wisdom and irrational thought, does at times exhibit certain patterns that can be used to help – but not guarantee – future price moves. Enter technical analysis and like methods of evaluation. But that sometimes irrational behavior, that “Random Walk” as it is called, is also present. Emotion, fear, and greed drive it regardless of underlying fundamentals of a company. And like you, when I find a system that generally works (none work perfectly 100% of the time), I will use it without too much question. Need I complicate a process and question why I make profit as long as I DO make profit? And that defines the Dogs of the Dow strategy.
Thanks for your comment.
Jim—Thank you for the article.
Jim: a fine article that I enjoyed. The aggregate yield data is impressive. Maybe you articulated this and I missed it, but for that yield data, does that presume that you re-allocate amongst the most current Dogs at the end of each year? Or at the end of June? In other words, I presume you want to stay in the doggiest of the Dogs at all times, right?
DR., thank you for the comment. How in the world you find time to share all you do within your area of expertise, then still have a moment to read and reply to others is beyond me. Simply amazing, sir. Simply amazing! And appreciated.
As to your question on reallocations within the portfolio: Reallocations are made only once per year. Normally this is done on the first business day of each new year, but there is no particular magic to that date. The Investment Advisor who came up with the idea, developed the performance data, and wrote his first book on the topic, Michael O’Higgins, used the first of each year simply because it was an easy date to use so as to be able to track data against the DJIA on a yearly return basis. He makes no claims to the contrary in his book of which I am aware, so I assume I am safe in saying this. But it is not – I say again, not – a requirement.
An investor can start at any point they wish. Just develop the list of the then-current top ten yielding stocks in the DJIA and buy equal dollar amounts of each. From that starting point, they investor can do one of two things when it comes to the rebalancing.
First, they can view tis initial purchase date as what I call a “stub” year. Let’s say they opened the account and made the initial buys on April 12. From that date forward, about 8 1/2 months, would be the stub year. Then, on January 2nd, they would rebalance according to the discipline making appropriate buy/sell decisions. And from there forward they will be on that calendar year cycle. This is helpful because all tracking data is usually based on that date of acquisition.
Or, they can stick to the date of April 12 as the rebalance date. It’s up to them. This may work out to give a better annual return number or a worse one. That cannot be known in advance. It just makes the comparative data that is available harder to calculate. Why cause yourself unnecessary trouble if there is no verifiable profit advantage?
The only caveat I gave clients was that, if the start date was on or after November 1 of any year, buy only the first 8 positions. Hold the cash that would have been used for the # 9 and 10 positions in reserve. Then, on January 2, rebalance the portfolio and use all the funds available.
Why do this? It’s because when you get down to the last 2 or 3 positions, the yield numbers are very often extremely close – there may be no more that a 0.20% difference between them at that point. So, even a small change in price, assuming the dividend remains constant, will reorder the stocks. You could buy the # 9 and 10, then just two months later, find it necessary to sell both because they have changed a bit and now others have replaced them in short order. That is, to me, unnecessary trading costs incurred. So I choose to sidestep it entirely and wait.
Hope that clears it up. It’s really not when an investor does it, it’s that they DO it at some point. Then follow the discipline with a dogged determination not to wax and wane based on current research opinion.
Thanks again for the reply. BTW, I also follow all your musings to the best of my quite limited ability (words of more than 4 syllables frighten me). I can’t even spell “Asprin” without looking it up, as I just proved. But I have stuck with the readings and now have eight or so positions in various biotechs that you have written on, and am quite pleased to say it has become and is a profitable venture. Thank YOU!
Best to you .. Perhaps you may be inclined to comment someday on GW Pharmaceuticals (GWPH) – my most profitable biopharma to date?
Regards,
Jim Skelton
The Blind Squirrel
I’ve traced Doctor KSS’s family tree and discovered that he’s a direct descendant of US President James Garfield who, according to Wikipedia, could simultaneously write in Greek with one hand and in Latin with the other. Its the only possible answer. 🙂
Thanks for this great series Jim.
It’s all Greek to me, Bud!
Thanks Jim, for the cogent answer.
I envy you your GW Pharma position. I would definitely hold on, as its meteoric rise seems to be set to continue. It is the only player of relevance, of credibility, in devising medicines based on defined blends of what is in marijuana.
The whole problem with marijuana as pharmacopoeia in this country has been our nation’s perennial irrational view of it. There are some drugs one should fear: cocaine, heroin, LSD, E, PCP…..all have devastating results. Marijuana is nowhere close in any way to it. It is notable lacking the two great hallmarks of abusable drugs: tolerance and habituation. Really habit-forming drugs establish states of great tolerance, where more and more is required to produce an effect. Most of us would get quite a buzz from 2 mg of morphine. A heroin addict may be barely buzzed by 200 mg. There is some small tolerance to marijuana, but nowhere close to that of hardcore drugs. Next is habituation. By this I mean that chronic use of it sets up in a state in which you have to have it, or else you face profound withdrawal consequences. People may casually speak of “being addicted” to chocolate, to Diet Coke, to marijuana, but in fact no matter how heavy your chronic use of these is, you can quit abruptly and never face withdrawal (you may crave, but you do not withdraw).
The drug industry has for years tried to devise synthetic agents that emulate marijuana, such as Marinol and Cesamet. In fact, these do little….the natural agent, having so many constituents, is much more effective. Marijuana relieves pain and anxiety, can raise the seizure threshold, and can help quench nausea. It is time that it be embraced as a useful drug. The problem with “medical marijuana” in the US is that this usually means smoking it, and in fact cannabis smoke is more lung-injurious, leads to COPD faster, than tobacco smoke. We need oral forms.
I think it is “high time” we all grew up about marijuana. I have never smoked it, but I mostly view it with benign neglect when patients do (unless they are also using serious illicit drugs). A few years ago I was treating an attractive young married woman for HCV. Halfway through treatment, she came in all upset. Three weeks earlier, she had called a repair person to their house to fix something. That indiscreet person had noticed a marijuana plant, grown by her husband. He had called the cops, who raided them and arrested them. Both lost their jobs, and so lost insurance, and so lost healthcare coverage, and so she had to stop her treatment and virus came back. For too long, we have used marijuana as a basis for a timid, lying morality….we prosecute it because it is easy….pot growers are not armed, mostly, and so bust them and you can claim you are “fighting the war on drugs” and yet can do so with no self-risk. This lunacy needs to stop.
Anyway, I would definitely stay in GWPH here. It is in an interesting position at the right time, and I know of no other marijuana stock play similarly poised. I’d sure rather chronic pain patients manage themselves with GW’s Sativex than with opioids!
Dr. KSS, it seems we have regressed re. marijuana over the course of the past 100 years.
At the turn of the 20th century (not that I was around at that time, I’m not as old as Alan),
one could go to the local drugstore to obtain cocaine,heroin and marijuana. Marijuana
wasn’t criminalized until 1937, by The U.S. Congress. So it seems we are starting to come
full circle.
Great article Jim.
Frank
Frank:
Want to know why and how MJ was criminalized. Use your research skills and do this:
Google William Randolph Hurst, he of the Hurst newspaper empire. Follow his involvement in the timber industry where he had huge holdings to provide the pulp for his newspapers to be printed on. He harvested trees on his own land, processed them, then sold back to himself at a fat profit. Then, look at what was happening at the same time with Marijuana, i.e. the Hemp business. Hemp had been around for centuries, used as a material for making all manner of things such as rope, clothing, and yes, high quality paper. It was very cheap, renewable, and could be made with little effort compared to the timber business. Now see how Hurst recognized this threat to a major profit center of his own and got in touch with his buddies in Hollywood. See how they produced the film “Reefer Madness” at his request, demonizing marijuana and all who would use it. One of the worst movies ever made, but highly effective propaganda. Follow how Hurst took that movie nationwide through his chains of movie theaters to “educate” the public on the evils of marijuana. Then trace how this new and evil perception of the plant was touted from pulpits everywhere and transmitted to politicians. The message was to outlaw this terrible affliction on our Nation or we will assume you are a supporter of debauchery and the deflowering of our young women and vote you out of office. The politicos caved, the plant outlawed, the prosecution of growers and users started, and here we are today. Hurst, by means of attacking use of marijuana, had successfully removed hemp as a competitor for that newsprint business. You can’t grow hemp without getting marijuana as a by-product. How ironic. And what genius on his part to find this way of eliminating the competition. And it had nothing at all to do with any supposed evil effects of marijuana. Nothing at all. Thank you, Mr. Hurst. ALWAYS follow the money!
Please look this up and do the research to find the TRUTH behind what we are dealing with today. Tell your congressmen and women to wake up to these facts and stop destroying so many lives, spending so much of our treasure, wasting so much of our law enforcements time and resources, and to no good end. It’s time to put William Randolph Hursts little scam of 80 or so years ago to rest.
Dr. KSS, thank you for that concise summation re GWPH in specific and Marijuana in general. I had not intended to start a discussion on the substance itself in this thread, but if readers so desire, let the missives began!
To be clear, I am 100% in favor of legalization of marijuana for both medicinal and responsible recreational use. Your comment about it not being addictive but having a “craving” effect is spot on. I say this not just from the standpoint of academic learning but from personal experience that I am not going to elaborate on at this time. The legalization Genie is out of the bottle and will not be stuffed back in, in my opinion. It will take years of re-education of the public perception that has been so erroneously reported over the past 75 years or so before the reality is accepted and the politicians feel free to finally do the sane thing. And while there is a downside to this, the greater benefit stands to be recognized. It can’t come soon enough for me.
As for investment in this space, I don’t recommend it in any company other than GWPH at present, and even then only as a speculative venture for those who are willing to take the risk. There are far too many companies out there that make great claims of having a product or process or equipment to offer which are more rooted in fantasy and dreams than reality. Tread lightly here. The phenomenal run we saw of January thru February this year in the stock prices of these pink sheet penny stocks is well past, and the fact is that, in almost all instances, the Emperor had no clothes. To try and pick among the debris left behind could be highly, highly dangerous to your net worth.
Thanks for your response. Your three points – (1) easily understandable, (2) simple to implement, and (3) not consume onerous amounts of time to maintain – do favor the Dogs of the Dow. However, for us tech savvy investors, there is a temporary advantage. I stress temporary because when any technology proves to be advantageous it will percolate through the system and everybody can use it and the playing field becomes level again. When this happens, the Dogs of the Dow will still be a winning strategy, and it really was not “different this time”.
Incidentally, the “Dogs of the Universe” is just another name for the O’shaughnessy “Trending Value” system that has been extensively back tested, but it takes considerable technology to implement. I could not do it without Ycharts.com and Zacks.com and some pretty fancy programming.
One more comment: Subscribing to Stock Gumshoe is a technological advantage. I do speculate a bit, and some of Dr. KSS suggestions have added spice to my otherwise dull portfolios
Hi Jim
I fully understand that you have been making the case for the Dogs as an investing strategy, and ‘if it aint broke, dont fix it’. I think I understand the concept and accept it……youre buying (relatively) low priced/high quality stock and being paid a dividend while you wait for an upturn. (of course, it assumes such shares have cycles, so the stock will be up at the end of 365 days….still, theres risk in all investing eh!)
But without changing those fundamentals, is it a good idea to sell ‘covered calls’ so gain profit/reduce losses? I mean, if you are gonna hold that stock for a year ‘come what may’, you may as well get it earning double time. Is this viable/advisable?
For others who may be less knowledgeable, heres a cut and paste from Investopedia;
When to Sell a Covered Call.
If you sell a covered call, you get money today in exchange for some of your stock’s future upside. (if any)
For example, let’s assume you pay $50 per share for your stock and think that it will rise to $60 within one year. Also, you’d be willing to sell at $55 within six months, knowing you were giving up further upside, but making a nice short-term profit. In this scenario, selling a covered call on your stock position might be an attractive option for you.
After looking at the stock’s option chain, you find a $55, six-month call option selling for $4 per share. You could sell the $55 call option against your shares, which you purchased at $50 and hoped to sell at $60 within a year. If you did this, you would obligate yourself to sell the shares at $55 within the next six months if the price rose to this amount. You would still get to keep your $4 in premiums plus the $55 from the sale of your shares, for the grand total of $59 (an 18% return) over six months (excl any dividends).
On the other hand, if the stock falls to $40, for instance, you’ll have a $10 loss on your original position. However, because you get to keep the $4 option premium from the sale of the call option, the total loss is $6 per share and not $10.
Scenario No. 1: Shares rise to $60, and the option is exercised
January 1 Buy XYZ shares at $50
January 1 Sell XYZ call option for $4 today
Expires on June 30, exercisable at $55
June 30 Stock ends at $60; option is exercised because it is above $55. You receive $55 for your shares.
July 1 Total Profit: $5 (capital gain in the stock) + $4 (premium collected from sale of the option) = $9 per share, or 18%
Scenario No. 2: Shares drop to $40, and the option is not exercised
January 1 Buy XYZ shares at $50
January 1 Sell XYZ call option for $4 today
Expires on June 30, exercisable at $55
June 30 Stock ends at $40; option is not exercised and it expires worthless because stock is below strike price. (After all, why would the option buyer want to pay $55/share when he or she can purchase the stock in the market at the current price of $40?)
July 1 Total Loss: -$10 + $4.00 = -$6.00, or -12%. You can sell your shares for $40 today, but you still keep the option premium.