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Summary

  • The Dogs of the Dow strategy has a powerful long-term performance track record for total return.
  • Since the strategy is focused on dividends, it should be considered by income investors.
  • Given the low beta of the strategy, and the outperformance on the total return, this strategy creates considerable long-term alpha.
  • I test the Yield Weighted Dogs & Equal Weighted Adjusted for Value Dogs to determine whether they out-perform the traditional Equal Weighted Dogs.

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, covered in yet another post. Today I am presenting an update on how the dogs barked year-to-date March 2014.

March has been a kind month to markets. The SPDR Dow Jones Industrial Average (NYSEARCA:DIA) is down 0.74% year-to-date, which is nice considering the 5.19% loss seen in January 2014. SPDR S&P 500 (NYSEARCA:SPY) is up 1.26%, having closed January 2014 down 3.52%, Guggenheim S&P 500 Equal Weight (NYSEARCA:RSP) is up 2.44%, having closed January 2014 down 2.96% and iShares Russell 2000 (NYSEARCA:IWM) is up 0.85%, having closed January 2014 down 2.77%. This return data excludes dividends. Adjusting returns for dividends paid out during the quarter, the SPDR Dow Jones Industrial Average, SPDR S&P 500, Guggenheim S&P 500 Equal Weight and iShares Russell 2000 returned (0.23%), 1.70%, 2.84% and 1.11% respectively.

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

The underperformance of the Dow suggests that mega-caps underperformed. However, since SPDR S&P 500 led iShares Russell 2000, large-caps outperformed over-all. The swing to large-cap outperformance signals a slight rise in risk aversion. That is healthy. The best performance came from Guggenheim S&P 500 Equal Weight ETF. This indicates that stock selectors are outperforming free-float market capitalization indices: they are able to generate superior total return by accepting a higher weight-age to size risk. Alpha is available, but we have to work to find it. And because both SPDR S&P 500 and Guggenheim S&P 500 Equal Weight both select the same stocks (S&P 500 companies), it is clear that capital allocation strategy has had an important role to play in the creation of alpha. Stock selection is important, but capital allocation has an important role to play.

What about the Dogs? 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 March, the SPDR Dow Jones Industrial Average closed down 0.23%, while the equal weighted Dogs closed up 2.13%. Thus clearly the Dogs outperform the Diamonds. The Dogs weighted by yield closed up 2.02%, outperforming the SPDR Dow Jones Industrial Average. And the Dogs weighted using the equal weight adjusted for value method closed up 2.33%.

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, and the yield weighted methodology, both beat returns generated from the simple equal weighted stock selection strategy (the traditional Dogs of the Dow strategy). Thus, it does appear that capital allocation can generate returns over and above returns generated through stock selection.

Here is a snapshot displaying how the various strategies performed year-to-date March. Merck (NYSE:MRK) was the Dog that barked loudest, followed by Microsoft (MSFT); the Dogs that whimpered loudest were General Electric (NYSE:GE), followed by Chevron (NYSE:CVX).

(click to enlarge)

Source: MaxKapital Archives

The chart above displays value of the portfolio based on prices as at 03/31/14 plus the dividend received year-to-date March 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 12/31/2013.

(click to enlarge)

Source: MaxKapital Archives

The following chart displays valuation (price only) as at 03/31/2014.

(click to enlarge)

Source: MaxKapital Archives

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

(click to enlarge)

Source: MaxKapital Archives

Disclosure: I am long MRK, INTC, PFE, CSCO, MSFT, GE, VZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.