Dogs of the Dow: what are they and why they’re important

If you’d followed the strategy since 2009, you’d have beaten the Dow Jones in six out of those 10 years. That’s not bad at all for such a simple strategy, though the number falls to five out of 10 when you compare it to performance of the broader S&P 500 index. The strategy also tends to go through good patches and bad patches: for instance, it performed very poorly during the GFC, and in 2020 yielded -12.6%, compared to the Dow’s 7.2%, and the S&P 500’s 18.4%.

That poor 2020 performance means on a 10-year-basis, the Dogs strategy has underperformed against both indices, posting an average annual return of 9.2% versus 11.4% for the Dow and 12.3% for the S&P 500. Since 2000, the Dogs have underperformed against the other two indices slightly more than half the time, tending to underperform during crises in particular.

There are two core theories at the heart of the Dogs of the Dow Strategy: firstly, that a stock with a higher dividend yield will have a better chance of beating the market than a stock that pays a lower yield.

The second is that the stocks on the Dogs list are likely there because they haven’t performed as strongly as others on the index (dividend yields rise as stock prices fall – so long as the amount the company is paying out remains the same) and may therefore be undervalued. Of course, the companies that make the list are often there for a reason and may well be facing challenges that won’t be resolved within a year. If they are really in trouble, they may also reduce their dividend, essentially blowing up the investment rationale.

However, the strategy is essentially a game of probabilities. It’s fairly likely that a few of the stocks will do poorly, but less likely that the majority of them will and the gains from the strongest performers will (hopefully) offset the weakness from others.

Of course, every index, from the FTSE100 to the Hang Seng has its winners and losers, so you may be asking yourself if it’s possible to apply the Dogs strategy elsewhere. The answer is that, technically, yes you could, though it’s unlikely to work in the same way. The reason is that the Dow Jones Industrial Average (DJIA) is made up of just 30 very large companies with long track records and relatively dependable dividend streams. Just take a look at the Dogs of 2019:

• IBM
• ExxonMobil
• Verizon Communications
• Chevron
• Pfizer
• Coca-Cola
• JP Morgan Chase
• Procter & Gamble
• Cisco Systems
• Merck

These are all very well-known companies, most of them household names. They are what many people would call “blue-chip” stocks and most of the time they perform relatively reliably in that they are unlikely to rise or fall rapidly in normal market conditions.

That’s not to say looking at high-dividend-paying or beaten-down stocks in other indexes is a bad idea – just that you would need to be very careful in adapting the Dogs strategy to other markets.

The Dogs of the Dow is inherently a conservative strategy, albeit perhaps a little riskier than investing in an index-wide ETF​. It’s relatively simple to implement and doesn’t require any involvement from investors outside of the first and last days of the year. Having a portfolio centered on very large companies may reduce the risk of heavy losses – outside of a financial crisis anyway – though it may also limit potential returns and so may not be attractive to investors who are comfortable in taking on a higher degree of risk.

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