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Investopedia defines the "dog" investing system as:

An investing strategy that consists of buying the 10 [index] stocks with the highest dividend yield at the beginning of the year. The portfolio should be adjusted at the beginning of each year to include the 10 highest yielding stocks.

In two recent articles, I discussed a five year back test for one of the longest running dividend stock picking systems, Dogs of the Dow. This article reports one year back test results applying the dog strategy to four of seven indices, including the component stocks of the Dow Jones Industrial Average. Most recently, in "Testing Forward vs. Actual Dividend Yields From March 2010 to March 2011 ", I compared projections with actual dividend yields for the year to reveal the margin of error in forward looking yield assumptions for each index.

Can Dividend Yields Predict Net Returns?

To answer this question, a "dogs of the index" investment strategy was back tested for seven indices. Tracking them for a year (March to March) revealed what net profit (or loss) was generated by making a $1000 investment in the top ten high yielders in each index then selling then all. Subtracting the initial investment and broker fees from dividends paid plus the gross profit from sale of shares revealed which indices generated the best net returns.

NYSE International 100 showed the most improved actual dividend yields as of March 2011 compared to those predicted in March 2010. However, when net gains are counted this collection of stocks bottoms out.

click to enlarge images

Five of the ten component stocks showed net losses. Nokia Corporation's (NYSE:NOK) $407.93 net loss of ($41.03%) was followed by Banco Santander (STD) losing $181.56 net (18.23%), Companhia Sidrugica (NYSE:SID) losing $82.40 (9.05%) despite a 2:1 stock split, France Telecom (FTE) losing $9.65 net (6.91%), and Westpac Banking Corp.(NYSE:WBK) losing $29.10 or (2.94%) for the year tested.

On the positive side YPF Sociedad (NYSE:YPF), BCE, Inc.(NYSE:BCE), and Telefonica S.A.(NYSE:TEF) produced triple digit net gains and two healthcare stocks AstraZeneca (NYSE:AZN) and GlaxoSmithKline plc (NYSE:GSK) were also positive. Total returns for NYSE International 100 dogs were negative $35.82 or (0.25%) for the year.

NASDAQ 100 index dogs threw dividends in excess of their March 2010 Yahoo Finance projections and showed solid price gains in 8 of 10 component stocks.

While Vodafone (NASDAQ:VOD) was projected to yield top dividends in 2010-11, for net gain Maxim Integrated Products (NASDAQ:MXIM) performed best for the year while VOD fell to second. Linear Technology (NASDAQ:LLTC) rounded out the top three. Microchip Technology (NASDAQ:MCHP) and Automatic Data Processing (NASDAQ:ADP) completed the top five. Other companies producing positive net gain numbers for team NASDAQ 100 were Mattel (NASDAQ:MAT), Paychex (NASDAQ:PAYX), and Millicom Cellular (MICC). It came through as a gainer despite paying no dividend for the year. Two stocks, Intel (NASDAQ:INTC), and Garmin (NASDAQ:GRMN) paid dividends but produced negative net results due to market price reductions. As a group the ten stocks representing NASDAQ 100 combined net price gains and dividends resulted in a $1,421.10 or 15.03% on $10k invested 3/22/10 and sold 3/21/2011.

Sectors 3x9 index is a composite derived by taking the three top dividend yielding stocks in nine Yahoo Financial business sectors and back testing the top ten yielding stocks out of the 27. The stocks so selected threw dividends of 3.05% in excess of their March 2010 Yahoo Finance projections and showed reasonable price gains for 4 and outstanding price gains for 2 of 10 component stocks.

Net gains for the period reveal Stonemore Partners (NYSE:STON) with a fourth ranking projected dividend yield of 12.07% showed the best net price gain of 56.03%. Otelco (OTT) produced the second best gain of 31.81%. Reasonable gains by American Capital Agency (NASDAQ:AGNC), Emergent Group (NYSEMKT:LZR), Vector Group (NYSE:VGR), Prospect Capital (NASDAQ:PSEC), and Cherokee (NASDAQ:CHKE)rounded out the profitable seven. Three more Sector stocks, Teekay Tankers (NYSE:TNK), Whiting USA Trust (NYSE:WHX), and Himax Technologies (NASDAQ:HIMX) were net gain losers for the year. Ten stocks comprising Sectors 3x9 combined price gains and dividends resulted in a $1,034.22 net or 10.46% gains from $10k invested 3/22/10 and sold 3/21/2011.

The Dow 30 index also threw dividends in excess of their March 2010 Yahoo Finance projections and showed solid price gains in 8 of 10 component stocks.

Returns for the period reveal Dupont (NYSE:DD) with a third ranking dividend yield of 4.62% showed the best net gain of 51.66%. Chevron (NYSE:CVX) produced the second best gain, followed by Verizon (NYSE:VZ), Coca-Cola (NYSE:KO), and Pfizer (NYSE:PFE) rounding out the top five. Three more Dow stocks, AT&T (NYSE:T), McDonald's (NYSE:MCD), and Kraft Foods (KFT) produced positive net gains. Two Dow "dogs", Johnson &Johnson (NYSE:JNJ), and Merck (NYSE:MRK) were net gain losers for the year. Ten stocks representing Dow 30 combined price gains and dividends resulted in a $1,845.96 net or 18.84% on $10k invested 3/22/10 and sold 3/21/2011.

Final results for this round show the ten Dogs of the Dow fetched top gains compared to those of NASDAQ, Sectors 3x9, NYSE International 100.

Furthermore, the question, "Can Dividend Yields Predict Net Returns?" is answered with a resounding, "NO", based on the numbers put up by the ten dogs of the NYSE International100 index. In this example, the index showing the greatest improvement in actual yields beyond those projected managed singularly negative net returns compared to three other indices.

The remaining question, "Which index dogs grabbed the most gains?" will soon be answered.

Next: Annual net returns for S&P500, Russell 2000, and Aristocrat Indices. We'll see...

Source: Comparing Dog Investing Strategies: Annual Net Returns for Various Index Components