The "Dogs of the Dow" theory (DOTD) was popularized in the early 1990s as a way to beat the broader stock market's (NYSEARCA:VTI) returns. Since then, the strategy has posted impressive results by outperforming the S&P 500 (NYSEARCA:SPY).
Who are 2013's "Dogs" and how does the strategy work?
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Dogs SnapshotThe DOTD strategy uses a relatively straight forward approach by selecting and rebalancing into stocks within the Dow Jones Industrial Average (NYSEARCA:DIA) whose dividend yield is the highest.
The theory behind choosing DJIA stocks with a high dividend yield is that they are closer to the bottom of their business cycle and are likely to see their stock price increase faster relative to lower yielding stocks.
The DOTD is an equal weighted portfolio strategy, meaning each of the 10 highest yielding stocks are owned the same proportion. For example, a $100,000 investment portfolio would allocate $10,000 to each of the 10 dogs.
Variations of the DOTD Theme There are variations of the DOTD strategy. The "Small Dogs of the Dow," for example, are composed of the five lowest priced stocks within the DJIA.
The ALPS Sector Dividend Dogs ETF (NYSEARCA:SDOG) is an ETF that applies the DOTD strategy, but on highest yielding S&P 500 stocks. SDOG equal weights its 50 stock portfolio at both the sector and stock level. Each stock gets 2% representation while each sector is given 10% exposure. SDOG is rebalanced quarterly and the actual holdings are reconstituted at the end of each year.
SDOG's annual distribution yield is 5% and the fund charges annual expenses of 0.40%.
Historical ResultsFrom 1992 to 2011, the DOTD strategy matched the annual return of the DJIA (10.8%) and beat the S&P 500 (9.6%), according to the Dogs of the Dow website.
The Small Dogs of the Dow posted even better results by gaining 12.6% over that same time frame.
Although both strategies have not beaten major stock benchmarks every year, their performance over longer periods has been good. This is true despite periods of underperformance like during the dot-com heyday (1998-99) along with the credit crisis (2007-09).
This Year's Names Dec. 31 of each year is the typical annual rebalancing date for portfolios using the DOTD strategy. For investors holding the previous year's "Dogs," the idea is to re-target your stock holdings back to a 10% weighting. Annual rebalancing also allows you to own more shares in the Dow stocks that have lagged in performance along with reducing overconcentration in the stocks that have run up in value.
The table below lists the 10 highest yielding DJIA stocks as of the market close on Dec.31, 2012. Rounding out the top three stocks on the 2013 list are AT&T (NYSE:T), Verizon (NYSE:VZ), and Intel (NASDAQGS:INTC). We've also listed the five DJIA stocks, (also known as the "Small Dogs of the Dow") with the lowest 2012 closing share price. Hewlett-Packard (NYSE:HPQ) and General Electric (NYSE:GE) are among the 2013's Small Dogs.
In summary, here's the lowdown on the DOTD strategy:
AdvantagesFairly easy strategy to employStocks held in the portfolio are established companies
DisadvantagesNot a diversified strategy and concentrates equity risk in just a handful of holdingsTrading transaction costs associated with annual rebalancing corrodes returns
Check out ETFguide's Income Mix Portfolio, which generated $10,422 in annual income in 2012. The portfolio is designed to generate high monthly income using covered call options. The Jan.2013 trade garnered $654 in monthly income.