2009 Dogs of the Dow

With the model portfolio almost fully invested at this point, I do not want to make any changes to it just yet and figured this would be a good time to revisit The Dogs of the Dow strategy. According to the Dogs of the Dow theory if you were to pick 10 stocks with the highest dividend yields from the Dow Jones Industrial Average (DJI) at the beginning of the year and hold them until the end of the year, your average returns over a period of time should be higher than the returns of the entire Dow Jones Industrial Average (DJI).

We have been tracking the returns of the Dogs of the Dow on SINLetter in real time (ok, with a 30 minute delay like the model portfolio) since 2006. The theory generated a lot of interest in early 2007 after it posted market beating returns of 24.80% for 2006. In the January 2007 edition of SINLetter I wrote,

I considered using the Dogs of the Dow theory once again to pick this month's featured stocks but after a gain of 58.19% in General Motors (GM), a gain of 45.98% in AT&T (T) and a gain of 37.06% in Merck (MRK), most of the stocks on this list can hardly be called "dogs". Given the high level of interest in the Dogs of the Dow theory, there is a possibility that some of these stocks may register additional gains in the first quarter of 2007 but I plan to abstain from the dogs this year with the single exception of Pfizer, which I already hold in my personal portfolio.

Just like any mutual fund or advisor that has a hot streak and attracts equally hot money, the theory failed to live up to expectations in 2007 and 2008. The 2007 dogs posted a loss of 1.38% when compared to a gain of 6.43% for the entire Dow Jones Industrial Average. The 2008 Dogs of the Dow posted a loss of 42.98%, underperforming the Dow by more than 9% thanks to an 87% drop in General Motors (GM) and a 77% decline in Citigroup (C).

After taking a hard hit in 2008, the 2009 Dogs of the Dow appear to hold true to the underlying value investing spirit of the theory and are worth looking into this year. Most financial websites are reporting Citigroup's dividend yield as over 9% based on a 16 cents quarterly payout in 2008. However Citigroup has decided to cut its dividend to just 1 cent per quarter going forward and hence the company did not make the 2009 Dogs list. While Altria is no longer on the list, Kraft Foods (KFT), which was spun off from Altria in 2008, made the cut.

2009 Dogs of the Dow

A year ago, it would have been hard to imagine GE sporting a single digit P/E or Bank of America trading in the low teens. While this list has many attractive stocks, Bank of America (BAC) and Pfizer (PFE) appear to be the most appealing on the list to me. With the acquisition of Countrywide and Merrill Lynch, Bank of America has become the largest bank in the country in terms of deposits and is likely to benefit from the refinancing wave that the lowest mortgage rate in decades has triggered. Bank of America is however a risky play as the integration of Countrywide has proven harder than expected and the company is already experiencing cultural issues even as it completes the acquisition of Merrill Lynch. Pfizer on the other hand is sitting on $35.29 billion in cash and investments and can more than fill any holes in its drug pipeline through small or large acquisitions. Pfizer has been a long-term holding in my personal portfolio and I plan on adding both Pfizer and Bank of America to the SINLetter watchlist for now.

Comments

[Billy Ford:]

Great story. I wouldnt expect any theory to work when you have companies such as GM and C losing their balance on the edge of a cliff. I like most of those companies that you have listed there, but I still think that you have to be cautious with BAC and JP...They seem to be in ok shape, but I will be surprised if the financial sector has seen its worst days. They are relatively cheap looking forward, but you have to wonder will they be able to get back to where they were without as much leverage as before

Jan 08 09:04 AM

[doylegroup:]

It's a wonder that all these experts are calling for a boom in refi's. How does that happen when the value of your property decreased by as much as 30%? So the only people that will be able to refi are those who either put more than 30% down or have owned their home for at least 5 years. IMHO

Jan 08 09:52 AM

[HBWOW:]

Is the derivative problem over with BAC and JPM much less the other large banks? I believe we have only seen the tip of the iceberg.

Jan 08 10:20 AM

[ChipSeal:]

I seem to recall that the dogs of the Dow could be improved by investing in the "dogs" two through four. Casting out the bottom dog avoided the the likeliest to be in real trouble and cut their dividends, or to be de-listed and such, and thus improved overall performance of the theory.

Jan 08 11:09 AM

[the don:]

The other bad news may be people who get laid off that have 401k loans out are resonnsible for paying them off, or being charged 10% penalty plus regular income tax. This shoe will drop soon. Most people who borrowed will not be able to pay back or pay the tax.

Jan 09 02:00 AM