Dogs of the Dow – A Look Back at 2012 & Forward to 2013

The new year is right around the corner and we’re not letting the fiscal cliff stop us from searching for investment ideas.  We've decided to turn to an old strategy, the Dogs of the Dow which was introduced by Michael O’Higgins, for some potential opportunities.  The Dogs of the Dow strategy suggests that you buy the top ten highest yielding stocks of the Dow Jones Industrial Average at the beginning of  each year.

Below is the performance of the "Dogs" for 2012.

Ticker Company 2012 Price Current Price 2012 Yield Current Yield YTD % Chg
T AT&T, Inc.                 30.5                 33.7 5.8% 5.3% 10.5%
VZ Verizon                 40.3                 43.5 5.0% 4.7% 7.9%
KRFT Kraft Foods                 38.0                 44.4 4.8% 4.4% 17.0%
MRK Merck                 37.9                 41.2 4.5% 4.2% 8.8%
PFE Pfizer Inc.                 21.9                 25.1 4.1% 3.8% 15.0%
GE General Electric                 18.2                 20.7 3.8% 3.7% 13.5%
DD Dupont                 46.6                 45.1 3.6% 3.8% -3.2%
JNJ Johnson & Johnson                 65.6                 70.1 3.5% 3.5% 6.9%
INTC Intel Corporation                 24.6                 20.5 3.5% 4.4% -16.7%
PG Procter & Gamble                 66.3                 68.0 3.2% 3.3% 2.5%
  Dogs of the Dow     4.16% 4.11% 6.21%

The top 10 highest yielding companies of the Dow averaged a return of +6.2% compared to the S&P 500 gain of +12.7% and our NLO portfolio gain of +7.4%.  The biggest laggard of the group was Intel (INTC) which is one of our top holdings, down -9% since our purchase.  Additionally, it should be noticed that Kraft Foods (KRFT) is no longer a component of the Dow Jones Industrial Average but has been the best performer of all ten companies.  As pointed out in our 2012 Nasdaq 100 Re-Rank Review (found here), stocks dropped from an index normally outperform, overall.  In the case of KRFT, it was dropped late in the year after spinning off a unit.

If tomorrow was the beginning of the new trading year, these companies would be the Dogs of the Dow for 2013.

Ticker Company Current Price Current Yield
T AT&T, Inc.                 33.7 5.3%
VZ Verizon                 43.5 4.7%
INTC Intel Corporation                 20.5 4.4%
MRK Merck & Co. Inc.                 41.2 4.2%
HPQ Hewlett-Packard                 14.0 3.8%
DD Dupont                 45.1 3.8%
PFE Pfizer Inc.                 25.1 3.8%
GE General Electric Company                 20.7 3.7%
JNJ Johnson & Johnson                 70.1 3.5%
MCD McDonald's Corp.                 88.7 3.5%
  Dogs of the Dow Average   4.07%

There are eight companies that are being carried over from the previous year.  Hewlett-Packard (HPQ) and McDonald’s (MCD) are the new additions.  Hewlett-Packard made the list after the stock slumped -45%.  Interestingly, HPQ has the lowest payout ratio using next years estimated earnings of $3.48.

The primary issue we have with the "Dogs of the Dow" strategy is that it assumes all 30 companies have similar retained earnings and payout ratios.  However, we believe that the dividend yield is a relative valuation and not absolute figure.  As an example, utilities and telecom companies will typically have higher yields than those of other industries such as technology.

As an alternative, we have come up with a different approach to the "Dogs" strategy to determine if there is any merit to our "relative value" assessment.  Instead of looking at the 10 highest yielding stocks of the Dow Jones Industrial Average, we will look at the top 10 stocks closest to their respective 52-week low.  We'll call this ‘Dogs of NLO’.

Here are the top 10 companies we came up with for 2013.

Ticker Company Current Price Current Yield
MSFT Microsoft Corporation           27.0 3.4%
MCD McDonald's Corp.           88.7 3.5%
INTC Intel Corporation           20.5 4.4%
DD Dupont           45.1 3.8%
AA Alcoa Inc.             8.6 1.4%
IBM IBM         192.7 1.8%
UNH UnitedHealth           54.4 1.6%
KO Coca-Cola           36.4 2.8%
MRK Merck & Co. Inc.           41.2 4.2%
CAT Caterpillar Inc.           87.7 2.4%
  Dogs of NLO Average   2.92%

It should be noticed that the dividend yield is considerably less than that of the Dogs of the Dow strategy.  Some could argue that having a low yield will likely result in a lower return, however, as we've demonstrated in an article dated titled "Low Yielding Stocks Offer Exceptional Gains" (found here), the one year gains for low yielding stocks can be outsized.  In another article dated November 10, 2010, titled "Comparing Two Dividend Strategies" (found here), a comparison of low dividend yielding stocks to high dividend yielding stocks, the low yielding stocks have outperfomed by an ever increasingly wide margin as time has passed (2-year updates found in an article titled "Comparing 2 Dividend Strategies: Redux").

Again, this article is to provide a look back at the Dogs of the Dow performance in 2012 and possible picks for 2013.  While we have offered alternative strategies, we haven’t back tested it therefore we cannot and will not guarantee the outcome.  However, we feel strongly that it has a higher chance of outperforming the strategy initiated by Michael O’Higgins in 1991. Only time will tell, so we'll be sure to check  back for a review one year from now.

Note: We've recently written about a technical breakout in Caterpillar (CAT) so we believed 2013 will be a great year for the stock.

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