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By David Berman

After two losing years, is the Dogs of the Dow strategy about to shine?

It has been a while since we discussed this strategy, an intriguing approach to investing that involves buying the 10 highest-yielding stocks on the Dow Jones industrial average at the start of each year and holding onto them for the next 12 months.

It’s an attractive idea, in theory, because Dow stocks are the bluest of the blue chips, and therefore unlikely to cut their dividends. When yields rise (and stock prices fall), it is usually due to short-term issues that are generally resolved pretty fast.

Until 2008 and 2009, that is – disastrous years for dividend-loving investors. Blue chip meant nothing when the Dow’s financial stocks hacked their once-impressive dividends down to pennies, General Electric Co. (NYSE:GE) cut its dividend for the first time since the Great Depression and General Motors Corp. declared bankruptcy protection, eliminating its common shares.

Suddenly, the Dogs of the Dow – so named because of the contrarian nature of the strategy – were looking very doggish. In 2008, when stock markets around the world were in full-melt mode, the Dogs fell 39 per cent (after dividends), or considerably worse than the 32 per cent decline by the Dow Jones industrial average.

In 2009, a year in which stocks continued to fall for the first two months of the year before staging a remarkable recovery, the Dogs posted a gain of 18.4 per cent – still worse than the 22.7 per cent gain of the Dow (again, after dividends are factored in).

In other words, the Dogs underperformed when broader markets were in decline and also underperformed when broader markets were on the rise, which isn’t good.

These are still early days for 2010, of course. But so far, the Dogs have begun to stir. This year’s lineup: AT&T Inc. (NYSE:T), Verizon Communications Inc. (NYSE:VZ), DuPont (NYSE:DD), Kraft Foods Inc. (KFT), Merck & Co. Inc. (NYSE:MRK), Chevron Corp. (NYSE:CVX), McDonald’s Corp. (NYSE:MCD), Pfizer Inc. (NYSE:PFE), Home Depot Inc. (NYSE:HD) and Boeing Co. (NYSE:BA).

Together, these 10 stocks have yields averaging 4.3 per cent (and as high as 6.7 per cent in the case of AT&T) – which beats the 2.6 per cent yield for the entire Dow Jones industrial average and has helped the Dogs outperform the Dow. Since the start of the year, the Dogs have a slim 1.2 per cent gain that edges past the 0.1 per cent decline by the Dow.

With financial markets stabilizing, high-profile dividend cuts hopefully a thing of the past and some dividends starting to move higher, markets appear to be less afraid of dividend-yielding stocks these days. If broad indexes continue to move sideways, those dividends could make all the difference between an underperforming portfolio and one that shines.

Source: Dow Dividend Strategy Is Finally Paying Off