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, MaxKapital (511 clicks)
Long-term horizon, value, growth at reasonable price, capital & stock allocation
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I wrote a post entitled Big Dogs, Small Dogs & Spy Dogs in late December. That got me thinking about how people spend much time on stock selection, while neglecting capital allocation and risk measurement, both equally important aspects of return generation in yet another post. Today I am presenting an update on how the dogs barked year-to-date February 2014.

February has been a kind month to markets. The SPDR Dow Jones Industrial Average (NYSEARCA:DIA) is down 1.14% year-to-date, which is nice given the 5.19% loss seen in January 2014. SPDR S&P 500 (NYSEARCA:SPY) is up 0.87%, having closed January 2014 down 3.52%, Guggenheim S&P 500 Equal Weight (NYSEARCA:RSP) is up 2.22%, having closed January 2014 down 2.96% and iShares Russell 2000 (NYSEARCA:IWM) is up 1.87% having closed January 2014 down 2.77%.

Year-to-date, performance ranking is Guggenheim S&P 500 Equal Weight, iShares Russell 2000, SPDR S&P 500, SPDR Dow Jones Industrial Average in that order.

In many ways this sequence of performance is encouraging. Enduring bear markets normally start off with smaller companies such as those included on the iShares Russell 2000 getting battered the most, while larger caps tend to get beaten up less. On the other hand, the decline in large cap companies is more likely a reflection of weaker global economic expectations. After all, large U.S. companies have significant exposure to global growth, while smaller U.S. companies are more leveraged to U.S. growth. The leadership from Guggenheim S&P 500 Equal Weight and iShares Russell 2000 suggest that the market's appetite for risk remains healthy.

The Dogs selection represents a stock selection strategy with a long established history of success. In this post, I am presenting the same selection in three ways to establish whether out-performance, over and above that generated by stock selection, can be generated through capital allocation. The first is the traditional equal-weighted strategy, which simply allocates capital equally to all Dogs. In the second capital allocation strategy, the Dogs are weighted by dividend yield and capital is allocated in a manner such that more capital is allocated to stocks with higher dividend yield: this strategy allocates capital with an emphasis on value, using dividend yield as the sole indicator of value. And finally, the third capital allocation strategy allocates capital using an equal weight adjusted for value methodology. You can read more about the equal weight adjusted for value method here.

Year-to-date February, the SPDR Dow Jones Industrial Average closed down 1.14%, while the equal weighted Dogs closed down 0.94%. Thus clearly the Dogs outperform the Diamonds. However, the Dogs weighted by yield closed down 1.23%, underperforming the SPDR Dow Jones Industrial Average. Fortunately, the Dogs weighted using the equal weight adjusted for value method closed down 0.84%.

Stock selection clearly added to returns as is evident from the outperformance of the Dogs over the Diamonds. But did we see outperformance added through capital allocation too? The equal weight adjusted for value capital allocation methodology beat returns generated from the simple equal weighted stock selection strategy. The underperformance of the Dogs weighted by yield strategy highlights the danger of using yield as the sole indicator of value.

I'll leave you with a couple of thoughts:

1) At the end of February 2014, Microsoft (NASDAQ:MSFT) is no longer a Dog. It is replaced by Coke, whose yield has risen to 3.19% versus Microsoft which is at 2.92%. The Dogs strategy is a passive one with a one-year view, and so I am not making changes to the portfolio. But I cannot help wonder whether re-weighting the Dogs periodically instead of annually might help evolve a strategy to outperform the Dogs.

2) The Dogs strategy is an income strategy. The one weakness of an income strategy is the use of yield as a single indicator of a stock's worth. Would a strategy buying the ten best valued Dow stocks outperform the Dogs. In my view the ten best valued Dow stocks include Chevron (NYSE:CVX), Exxon (NYSE:XOM), The Travelers Companies (NYSE:TRV), Pfizer (NYSE:PFE), United Health (NYSE:UNH), International Business Machines (NYSE:IBM), Microsoft, Wal-Mart (NYSE:WMT), AT&T (NYSE:T) and Verizon (NYSE:VZ). This list includes only five of the 2014 Dogs, including Microsoft, which is a Dog no more.

3) Even looking at value, which considers dividend yield as one of several key determinants of value, is not without risk. For example, at present, Telecom as a sector looks at risk to disruption through innovation. Google (NASDAQ:GOOG) has already disrupted the advertising industry where it now dominates. Will its high speed internet delivery capability lead to disruption of the Telecom sector next? Facebook (NASDAQ:FB) is now a challenger to Google in the advertising industry, but with its acquisition of WhatsApp, which plans on offering free voice, it also threatens to disrupt the Telecom sector. The U.S. is the most innovative nation, and so that is where first sector or industry disruption is often seen. Might it make sense to invest in overseas Telecom, where the impact of disruption would occur with a lag, allowing time to exit as evidence of successful sector disruption in U.S. mounts. Might it make sense to avoid Telecom, instead focusing on alternative income yielding sectors. And while it won't make sense for income investors, it might actually make sense to invest in the disruptors if and when an appropriate value opportunity arises.

I digress. This post is about the Dogs, not about fear of Dogs. Below you will find data for the 2014 Dogs.

Here is a snapshot displaying how the various strategies performed year-to-date February. Merck (NYSE:MRK) was the Dog that barked loudest, followed by Pfizer. And the Dogs that whimpered loudest were General Electric (NYSE:GE) followed by AT&T .

(click to enlarge)

Source: MaxKapital Archives

The chart above displays value of the portfolio based on prices as at 02/28/14 plus the dividend received year-to-date February 2014. It represents total return (including dividends) based performance.

Below you will find additional charts.

This chart displays the stock selection and capital allocated as at 12/31/2014.

(click to enlarge)

Source: MaxKapital Archives

The following chart displays valuation (price only) as at 02/28/2014.

(click to enlarge)

Source: MaxKapital Archives

And this final chart displays the dividends received year-to-date February.

(click to enlarge)

Source: MaxKapital Archives

Source: How The Dogs Barked Year-To-Date February 14