Despite a pricey, aging bull market, long term investors must stay the course. To reduce risk, look for out of favor, inexpensive, dividend yielding stocks. An interesting and profitable way to do that is the Dogs of the Dow strategy.
The “Dogs” are the ten-highest yielding Dow stocks as of each January 1. This classic strategy divides your portfolio by ten and invests an equal amount in each at the year’s start. At year end, liquidate and repeat.
The strategy has a successful long-term record. Ending 12/31/16, the Dogs strategy has bested both the Dow itself and the S&P 500 over the last year, three years, five years, and decade.
Studies have shown that dividend payors outperform with less risk. If dividends are being paid, profits are more likely being generated. Buying the high yielders introduces a value discipline. Many companies pay dividends, but insisting on high yielders reduces the risk of overpaying.
Sticking with Dow stocks reduces further risk. Dow components are invariably industry leaders, with unusual resources that permit them to attract top talent and take a longer term approach.
This looks like an opportune time for the Dogs because value stocks are so out of favor. The Dogs themselves, a type of value strategy, have lagged year to date, returning just 5.4% this year versus the Dow’s 10.4% and the S&P’s 9.1%. In fact, the small Dogs have returned just 3%
We believe markets and prices revert to the mean. At some point, after money has chased the outperformers long enough, the abandoned stocks become too cheap and flows reverse. Value stocks are attractive under that analysis.
Couple the Dogs strategy with other fundamental research. Use the ten Dogs as an initial screen. You could then select those Dogs from weak industries. If an entire industry is weak, the apparent cheapness of a Dog within that group may not be an issue intrinsic to the company. Entire industries don’t disappear in the same way that an individual company might.
Research the Dogs based on other proven strategies. Free cash flow is critical, so a low stock price relative to that free cash flow is a great screen. Consider, too, for very cyclical companies, a low stock price relative to revenues per share. Low price to earnings ratios and low debt levels also make intelligent additional inquiries.
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Exxon (XOM) and Chevron (CVX) are at the top. Energy is by far the worst performing sector this year. Exxon and Chevron have lagged the Dow and the overall market dramatically, down 12.5% and 5.3% respectively, consistent with the industry. Exxon’s yield is just over 4%, the Dow’s third highest, while Chevron’s is just shy of 4%, the Dow’s fourth highest.
General Electric (GE) looks appealing. At 3.9% it boasts the Dow’s fifth greatest yield. If you are attracted to the small Dogs performance, GE has the (dubious) distinction of having the lowest share price, now under $25 per share. This conglomerate must turn operations around; expect to see calls to break up if results don’t improve fast. GE has already taken the first step, switching CEOs.
Finally, consider Pfizer (PFE). The health care sector has been battered by political concerns; leaders on both sides of the aisle debate the Affordable Care Act amid hand wringing over medical costs. Pfizer’s competitive advantages, its financial strength, its robust research and development program, and largest sales force in the world will ultimately allow it to thrive no matter what happens in Washington. Its stock price is the Dow’s third lowest and its yield at 3.8% the sixth highest.
Note: David G. Dietze, JD, CFA, CFP™ is President and Chief Investment Strategist of Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Avenue, Summit.
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