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The Dogs Faltered in the Final Few Laps of 2012

The Dogs of the Dow stocks put in a fairly solid showing last year. After falling behind in the first quarter, the 10 stocks battled back to gain a small lead over the other 20 Dow Industrials by the end of July. Unfortunately, from there on the mutts steadily lost ground every month. Notably, the December quarter was the worst period of the year for the group, and the only negative one, in terms of absolute performance.

Looking at the final numbers, the Dogs posted a respectable gain of 7.1% for 2012. However, even after factoring in the dividend yield advantage they held throughout the year, it was no match for the solid 13.6% advance posted by the 20 Dow components excluded from the Dogs. For comparative purposes, an equally weighted position in all 30 Industrials would have shown an 11.5% increase in market value over the period.

Sharp-eyed readers will note that this last figure differs somewhat from the 7.3% advance reported for the Dow Jones Industrial Average index. As a refresher, the index is price-weighted. This simply means that higher priced stocks tend to have a greater influence on its performance. For example: Changes in the price of IBM (IBM - Free IBM Stock Report) shares will carry considerably more weight than movement in something like Intel (INTC - Free Intel Stock Report). To mirror something closer to “real world” results, our calculations for the Dogs strategy are based on an equally weighted investment in all stocks at the start of the year.

Saints and Sinners

To be sure, the Dogs had some solid winners in the bunch last year. This included our original Kraft Foods holding, which later split into Kraft Foods Group (KRFT) and Mondelez International (MDLZ). A pre/post-split buy-and-hold position would have yielded an overall gain of 18.2% on the original investment. Elsewhere, General Electric (GE - Free General Electric Stock Report) returned 17.2%, Pfizer (PFE - Free Pfizer Stock Report) was up 15.9%, and AT&T (T - Free AT&T Stock Report) shares advanced 11.5%. These returns were weighed down by a 15% slide in Intel’s shares, and a 1.7% dip in DuPont (DD - Free DuPont Stock Report) stock.

But even if we ignore the two laggards dragging down the bunch, the Dogs had some stiff competition from the rest of the Industrials. Most notably, Bank of America (BAC - Free Bank of America Stock Report) enjoyed a spectacular rebound after a lousy 2011, advancing 108.8% for the year. And the 47.1% increase in Home Depot (HD - Free Home Depot Stock Report) shares didn’t hurt either. But the “non-Dogs” also had some clunkers. Namely the sizable 44.7% drop experienced by Hewlett Packard (HPQ - Free Hewlett Packard Stock Report), and the 12.1% fall in McDonald’s (MCD - Free McDonald's Stock Report) shares.

For 2013, Minor Changes In The Lineup

One of the key attractions of using the Dogs of the Dow strategy is that it requires very little time spent doing research. One simply takes the 10 highest-yielding Dow Industrial Issues at the start of the year (or any other period, for that matter) and invests an equal sum in each issue. Then, 12 months later, the whole process starts over. More often than not, many of the same stocks will remain on the list from one year to the next, simplifying things from an accounting perspective (no sales gains/losses to report) and also helping to lower broker transaction costs.

This year is no different, with only two changes to the list. Since Kraft split in two, with neither of the resulting entities included in the Dow Industrials, it’s no longer up for consideration. We also bid adieu to Procter & Gamble (PG - Free Procter & Gamble Stock Report), which didn’t make the cut for this year’s highest yielding Dow stocks. Replacing them we have Hewlett-Packard and McDonald’s which, in the wake of their weak performances last year, now have more attractive yields. In order of current yields, 2013’s Dogs are made up of the following:

 

Stock

Ticker

Yield

AT&T

T

5.14%

Verizon

VZ

4.68%

Intel

INTC

4.22%

Merck

MRK

4.06%

DuPont

DD

3.93%

Pfizer

PFE

3.71%

General Electric

GE

3.60%

Hewlett-Packard

HPQ

3.50%

Johnson & Johnson                         

JNJ

3.45%

McDonald’s

MCD

3.40%

That, of course, is anybody’s guess. While the Dogs have beaten the Dow 30 Industrial Average’s performance in two of the last three years, they’ve only come out ahead in three of the last seven. Over the longer term, the relative performance is more even. But simply beating the Dow is not the be-all and end-all of this trading strategy. Of particular interest to income investors is the fact that the Dogs start every year with a distinct advantage over the rest of the Industrials. This time around it’s a combined yield of just under 4.0%, versus about 2.6% for the index as a whole. That may not sound like much. But in a world where money-market funds and bank accounts pay about one-tenth of a percentage point (if that), and with the Federal Reserve resolving to keep things that way until at least 2014, solid blue chip stocks with good yields tend to be sought out by a wide group of investors, both retail and institutional, suggesting underlying demand for these shares will remain strong, if not increase, in the quarters ahead.

At the time of this article’s writing, the author did not hold positions in any of the companies mentioned.