Can the Dogs of the Dow Catch Up by December?

The Dow Jones Industrials (DJINDICES: ^DJI) have continued to reward investors during 2017, posting gains of nearly 12% so far this year. In the past, investors have been able to get even better performance by following the Dogs of the Dow strategy, which emphasizes the most dividend-friendly stocks among the 30 companies that are components of the Dow Jones Industrial Average. This year, though, the Dogs have lagged behind the Dow, but some signs of life in recent months suggest that the strategy could be catching up to the overall market.

How the Dogs of the Dow work

Dividend investors are drawn to the easy-to-understand idea behind the Dogs of the Dow strategy. How it works is simple. At the beginning of the year, take the 10 Dow stocks with the highest dividend yields. Invest the same amount of money in all 10 stocks and hold on to them for the entire year. If you want to keep using the strategy, do a fresh evaluation at the end of the year, making replacements as necessary to ensure that you have the 10 highest-yielding Dow stocks at that time.

One reason the Dogs of the Dow strategy has been popular is that it has tended to perform well. It has done better than the Dow in six of the past seven years, while also giving investors more lucrative total dividend payments as income.

What's happening with the Dogs of the Dow in 2017?

Despite its good recent track record, the Dogs strategy doesn't always lead to outperformance. This year in particular, several things are holding the Dogs back.

First, key sectors that almost always play an important role in the Dogs' performance aren't doing well in 2017. The energy industry is still going through tough times, and that has the average's two main oil and gas players down so far for the year. The telecommunications sector is also struggling due to price wars among top players in the U.S. mobile market, and that has Dow component Verizon down more than 13% on the year.

Conversely, the Dogs don't have their proportional share of truly strong performers. The group isn't entirely without good stocks, as aerospace giant Boeing and heavy-equipment specialist Caterpillar have both jumped out to big gains. But when you look more broadly, those two stocks are the only Dogs that number among the 11 Dow components that have posted gains of 15% or greater so far in 2017. By missing out on better returns among stocks in the health insurance, technology, consumer goods, and financial sectors, the Dogs haven't been able to run as fast as their non-Dog counterparts.

What's next for the Dogs of the Dow?

The best prospects for the Dogs of the Dow to catch up involve a reversal of these and other adverse trends that have held back their component stocks. Energy prices have remained stubbornly low, but a combination of industry factors could lead to a rebound in crude that in turn would lift shares of the energy giants among the Dogs. Greater certainty about the future of drug pricing in the U.S. could drive greater enthusiasm for the two pharmaceutical companies in the Dogs of the Dow, while rotation into some of the older technology names would disproportionately benefit users of the strategy.

The Dogs of the Dow aren't lagging behind the Dow Jones Industrials, but a difference of roughly 4 percentage points isn't too much to make up in the next three to four months. It's too early to count the Dogs out in September, and a lot could happen to help the Dogs of the Dow extend their winning ways this year.

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*Stock Advisor returns as of September 5, 2017The author(s) may have a position in any stocks mentioned.

Dan Caplinger owns shares of Boeing. The Motley Fool owns shares of and recommends Verizon Communications. The Motley Fool has a disclosure policy.