Dogs of the Dow Could Be Investors’ Best Friends

Dogs of the Dow Could Be Investors’ Best Friends

REUTERS/Rick Wilking

Last year, the one popular investment strategy that paid off – generating returns far higher than those offered by any market index as well as the majority of U.S. equity mutual funds – was snapping up the so-called Dogs of the Dow. Collectively, the 10 Dow components with the highest dividend yields on January 1, 2011 ended up delivering a gain of 12.2 percent – or 17.2 percent once dividends were added to the mix – leaving most other investment strategies in the dust.

Will lightning strike twice? Conventional wisdom says history is a pretty poor guide – and as every investment prospectus out there reminds us, past performance is no guarantee of future results. And yet…the environment in which those dogs flourished last year hasn’t changed much, and many investment pundits believe we are condemned to struggle with the same macro issues in 2012, from the European sovereign debt crisis and the fear that it will cause a global economic slowdown to the budgetary uncertainty in the United States as the presidential election battle moves into high gear.

When it comes to buying the Dow’s dogs, the real question may well be – why not? After all, it’s a simple and straightforward strategy with no complex quantitative screens required or bothersome derivatives positions to manage (unless, of course, you want to hedge the risk of owning troubled telecom stocks). All that an investor needs to do is identify the 10 stocks in the Dow Jones Industrial Average with the highest yields as of January 1, and buy a portfolio in which these are represented with an equal weight.

The strategy seems to work best in bear markets, as analysts have pointed out repeatedly, so if your gut is telling you that corporate earnings are likely to be much better this year than analysts now expect and that the market will respond as much to that kind of news as it will to the general anxiety over the fate of the eurozone or U.S. budget wars, you may want to think twice.

On the other hand, if you love the idea of investing for dividend yield and aren’t sure where to start, the Dogs of the Dow at least provides one strategy to pursue. This year’s dogs all offer yields that are north of 3 percent – not too shabby in a market environment when Treasury securities and bank CDs can yield half that level.

There are two big caveats, however. First of all, the reason that the dogs are dogs is that they are, well, dogs. In most cases, the reason that their yield is so high is that their stocks have plunged or lagged the rest of the market.

AT&T (T), the top dog, offers a yield of 5.76 percent, but it also has some significant business issues. Demand for smart phones is booming, but that means AT&T will have to pay up to acquire fresh spectrum to serve any customers it gains by offering discount-priced phones. One attempt to do so – the $39 billion bid for T-Mobile – collapsed amid regulatory opposition, leaving AT&T owing T-Mobile’s owner, Deutsche Telekom, a whopping break-up fee of $4 billion. No wonder analysts are scaling back their earnings projections for the company.

The pharmaceutical companies on this year’s list of dogs have been battered by investor fears about a declining pipeline of new blockbuster drugs and competition from generic drug manufacturers on existing big sellers.

And the list goes on – nearly every dog has a shadow of some size hovering over its head.

The second caveat is that investors can’t hang around and wait for the dogs to show signs that they’ll do as well in 2012 as they did last year. In some years, the month of January has been a big contributor to the overall return of the dogs. So if you want to hop aboard this bandwagon, be prepared to place your bets on the dogs while they are still untrained puppies. And there’s no guarantee that even Caesar Milan, aka the Dog Whisperer, will be able to whip them into shape by the end of December.

Still, it does seem as if some investors are willing to place those bets; yesterday shares of some dogs, including AT&T, General Electric (GE), DuPont (DD) and Intel (INTC), handily outpaced the Dow and other market indicators.

This year’s dogs, with their dividend yields, are:

AT&T (T) – 5.76%
Verizon Communications (VZ) – 5.06%
Merck & Co. (MRK) –4.40%
Pfizer (PFE) – 4.04%
General Electric (GE)  – 3.67%
DuPont (DD) – 3.50% 
Johnson & Johnson (JNJ) – 3.49%
Intel (INTC)  – 3.37%
Procter & Gamble (PG) – 3.16%
Kraft Foods (KFT) – 3.10%