The Dogs Appear To Be Having Their Day

As we’ve noted in the past, the Dogs of the Dow is largely a contrarian strategy. When you start off the year, you are generally picking the worst performers among the blue chips, as reflected in their comparatively high yields. When markets are booming, investors will lean towards those stocks showing the best price movement of late. The first quarter of 2012 was a perfect example of this phenomenon, as the Dogs returned a relatively meager 5.2%, compared to a gain of 11.2% for an equally weighted position in the Dow Jones Industrials as a whole, and an even more impressive 14.2% advance for the 20 Dow stocks excluded from the Dogs.

But things change, as they say, and the second quarter was not quite so kind to most investors. May was a particularly brutal month, and a bit of a bounce back in June was not enough to save the quarter, with all the major U.S. stock indexes showing a decline.

However, it was a decidedly different story for the Dogs, as these unloved old-line industrials returned a respectable 2.7% for the period. This compares to a decline of 2.7% for a balanced investment in all the Dow stocks. (We should point out that the Dow Jones Industrial Average itself was down only 2.5% for the interim. However, this popular benchmark is a price-weighted index. That is to say, higher-priced issues like International Business Machines (IBM - Free IBM Stock Report), for example, will have a greater impact on the overall index’s moves, and account for differences against “real world” results.)  And what about those “non-Dogs” that were doing so well early in the year? They shed 5.2% in the second quarter, giving up nearly all the advantage they held at the end of March.

Behind The Numbers

With all the recent stock market volatility, along with a steady stream of less-than-inspiring reports from the euro zone, it’s no real surprise that so-called defensive issues have been back in vogue of late. These are the companies whose products and services remain in high demand, regardless of the economic outlook.  

In keeping with this theme, the Dog team’s performance in the quarter was led by the two telecom giants Verizon (VZ - Free Verizon Stock Report) and AT&T (T - Free AT&T Stock Report), which tallied gains of 16.2% and 14.2%, respectively. Meanwhile, a solid 8.7% advance on the part of Merck & Co. (MRK - Free Merck Stock Report) shares didn’t hurt.

Of course, all was not rosy in the canine world. Namely, Procter & Gamble (PG - Free Procter & Gamble Stock Report) continued to stumble, shedding 8.9% in market value. The consumer packaged goods maker is suffering from slow economic growth, rising commodity costs, and negative currency exchange effects. Elsewhere, more-economically sensitive Intel (INTC - Free Intel Stock Report) stock dropped 5.2% and DuPont (DD - Free DuPont Stock Report) shares fell by 4.4%.

Ahead By A Nose

So the theory that the Dog stocks tend to do better in down or flat markets is holding true. Indeed, they outperformed the rest of the Dow components each month in the second quarter. Moreover, totaling up our scorecard for the first half, we note a practical dead heat, with the Dogs up 8.1% and the rest of the pack showing a gain of 8.2%.

But wait! We’re leaving out an important factor. Remember, the key criteria for this system is to select the 10 highest-yielding Dow stocks at the start of any year. This serves a two-fold purpose. One, it helps us identify those issues that (justly or not) have been beaten down of late. But it also provides a boost in the form of an underlying income stream. And that, as long-term investors are fully aware, can make all the difference. (see Small Payouts Play A Big Role In Long-Term Returns). Over shorter periods, of course, the difference is very small. But in our case, the 10 Dog stocks had an average yield just shy of 4.0% at the start of the year. Just enough of an advantage, as it turns out, to put them slightly ahead for total return through the first six months.

New Dogs For Old

One of the benefits of the Dogs of the Dow system is that it can be initiated at any time. That is to say, there’s no reason to wait for the start of the year, so long as you remember to stick to 12-month periods. Taking a look at the current list of 10-highest yielding Dow stocks, we find that someone starting today would have a portfolio line-up that’s quite similar to the one we started the year off with. In order of their current yields, we have AT&T, Verizon, Merck, Pfizer (PFE), Procter & Gamble, Johnson & Johnson (JNJ - Free Johnson & Johnson Stock Report), DuPont, JPMorgan Chase (JPM - Free JPMorgan Chase Stock Report), Intel, and Chevron (CVX - Free Chevron Stock Report). The only two names that fell off the 2012 list were General Electric (GE - Free General Electric Stock Report) and Kraft (KFT - Free Kraft Stock Report), which were replaced by JPM and CVX. This also serves to highlight yet another attractive feature of the Dogs trading strategy. Namely, that it tends to result in low turnover, which, in addition to making record-keeping simpler, helps cut down on commission costs.

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