Dogs Of The Dow
The Dark Side

The Dogs of the Dow is simple and it works, what isn’t there to like?

Well, depending on who you ask, quite a bit.

Dividends are a traditional way for companies to create value for shareholders. But growth companies are expected to create value for shareholders by growing, not by paying dividends. The Dow Jones Industrial Average contains both types of companies.

As a result, if only dividend yield is considered, some components will never be selected as Dogs of the Dow. For example, for Hewlett-Packard (HPQ) ever to be included in the list as a high yield stock it would probably need to be trading at 20% of its historical pricing. Maybe it would be a good buy at that point, but has it ever made the list?

After General Motors (GM) suspended its dividend, it could no longer pass the screen. Subsequently, it folded and was removed as a DJIA component.

These examples illustrate that not all components of the DJIA will actually be candidates for selection if only dividends are considered.

The workaround is to use Net Payout Yield.

Other common criticisms

One criticism is that only US companies are included in the DJIA. Therefore, you miss growth in emerging markets. This is not really a valid criticism since the companies included in the average are multi-national companies. And recovery, not growth is the feature of the strategy.

A second criticism is that although these are large stable companies, likely to recover, the universe of stocks is limited to the 30 components of the DJIA. The meltdown in 2008 and the demise of several large companies (including GM, a DJIA component) put an end to the to-big-to-fail concept. A simple solution (if you agree with this criticism) is to screen a broader universe of large cap stocks using a yield strategy and recognize that company failure is still a possibility.

Perhaps the most damning criticism is that so many people use the strategy it is a victim of its popularity. This is more commonly a problem when popular stock screens pick less liquid stocks than DJIA components.

For example, when trading the AAII Zweig screen several years ago, I noticed what seemed like disproportionate activity in companies passing the screen the day following the availability of the data. The Dogs have huge average trading volumes but may be susceptible to this phenomenon if enough mutual funds participate in the strategy.

Variations

There are variations to the base strategy to overcome these criticisms. The variations can turn this simple strategy into a valuable component of a portfolio. Learn about the variations and the screens to implement them.

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