Dogs of the Dow: Will They Bark or Bite in 2013?

Dogs of the Dow: Will They Bark or Bite in 2013?

iStockphoto/The Fiscal Times

Sometimes, the Dogs of the Dow faithfully do exactly what they are supposed to, delivering better returns that investors could earn from any stock index or many actively managed portfolios. Other times they are just dogs, curling up in the sun for an afternoon nap while the rest of the market outpaces them. It seems as if the results for 2012 fell squarely in the middle of those two extremes.

The Dogs of the Dow strategy – investing in the 10 Dow Jones Industrial Average components with the highest dividend yields on the first day of the year – was one of the most successful strategies that an investor could have used in 2011. The same strategy this year was more disappointing. The 2012 Dogs of the Dow have generated an average total return of 12.4 percent (as of the beginning of this week), compared to 15.5 percent for the S&P 500. More significantly, even though the portfolio didn’t include one of the worst performers among the 30 Dow components – Hewlett-Packard (NYSE: HPQ), down 43.3 percent – the Dogs still lagged the collective return of the 20 other Dow members.

That larger group – let’s call them the Cats, just for fun – has posted an average total return of 13 percent, including that outsize loss on the part of Hewlett-Packard. If you take HP out of the mix, the 19 remaining Cats ended up with an average total return of 16 percent, or nearly 30 percent better than that recorded by the Dogs.

The problem is that while the Dogs didn’t include the mangiest mutt of the Dow – Hewlett Packard – the outsize yields didn’t compensate for the relatively poor performance of many of the stocks themselves. So while Dog stocks Merck (NYSE: MRK), Pfizer (NYSE:PFE) and General Electric (NYSE: GE) all delivered a total return north of 20 percent, the “Cats” portfolio included five stocks that did the same, and one – Home Depot (NYSE: HD) – whose total return of nearly 54 percent has more than offset Hewlett-Packard’s woes.

The broader environment in which the Dogs flourished in 2011 may not have altered all that much in 2012, but the outlook for some sectors and companies did change, causing the Dogs to droop. Most notably, 2012 proved to be the year in which data confirmed that the housing industry is on the road to recovery, and investors bid up the prices of homebuilding stocks and others – like Home Depot – whose profits are tied to the industry’s wellbeing. Conversely, some Dow Dogs suffered from setbacks, ranging from a cyclical downturn in the chemicals industry – DuPont (NYSE: DD): total return of 0.9 percent – to a possibly secular shift in the semiconductors industry as tablets and smartphones take over. Intel (NASDAQ: INTC) has posted a loss of 12.3 percent, including its dividend payments.

Indeed, of the ten Dow Dogs, only two appear to have “graduated” from the group this year. (A third, Kraft Foods Inc., announced in August that it would split into two separate companies, each with its own publicly traded stock; I have removed it from the calculation, meaning that the average total return is based on the performance of the nine survivors.) Another seven companies will be back in the Dogs of the Dow portfolio in 2013, at least based on their current yields.

Once again the probable 2013 Dogs of the Dow all offer yields that are above 3 percent, a level that remains attractive in light of the astonishingly low yields available in the bond market. Still, while the top dog remains AT&T (NYSE: T), the telecommunications giant’s yield is lower, at 5.24 percent, compared to 5.76 percent a year ago at this time. This reflects the insatiable appetite of investors for some kind of income at a time when many market players worry that bond yields don’t fully reflect the real risks associated with the securities in question, particularly in the case of the high-yield corporate market.

The three newcomers to the Dogs of the Dow portfolio for 2013 appear likely to be HP (whose plunging share price has driven the yield on the stock up to 3.6 percent, although analysts point out that the company’s cash flow may mean that dividend isn’t “safe”), McDonald’s (NYSE: MCD, with a 3.5 percent yield) and a former darling of growth investors, technology stock Microsoft (NASDAQ: MSFT). The latter may stun many who remember its high-growth glory days but the software giant looks likely to end up in the company of Verizon (NYSE: VZ), Johnson & Johnson (NYSE: JNJ) and Merck, but its 3.4 percent yield qualifies it for inclusion, with two weeks still to go before the end of the year.

The list of 2013 Dogs does seem to have one thing going for it: With the exception Hewlett-Packard, there are few companies on the list whose dividend payouts are clearly unsafe. These may not be high growth stocks – and thus their total returns may once again lag the index and even their rival “Cats” within the Dow – and each individual company may possess some kind of obstacle or shadow hanging overhead. But investors eager to find a safe haven may find these high-yielding, blue-chip stocks a good place to begin their quest. Take a careful look at this year’s litter and pick out the puppies with pedigrees and potential.