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A previous article described criteria by which the S&P Index Committee manages the S&P 100 list for size and diversity. The article concluded that individual investors would be well served to adopt stringent rules and high standards for stocks included in their own portfolios.

In response to that advice, this article describes a back test ruled by one simple criterion of yield to rank dividend paying stocks. Known popularly as the Dogs of the Dow strategy, I like to call it the "Dogs of the Index" strategy when I apply it to lists of stocks other than those published by Dow Jones (ACME Group Company).

For this back test report I have used the Dogs of the Dow [Dogs of the Index] yield ranking system to select the top ten stocks from the S&P100. The purpose of the test is to demonstrate the system's trading successes and failures over seven years from June 14, 2004 to June 13, 2011.

Unfortunately at least three big S&P 100 dividend payers from 2004 namely, SBC Communications (SBC), General Motors (GM), and Boise Cascade (BBC) are not factored into this back test because financial history is only available online for companies still active enough to file financial reports. Merged, deleted, and reorganized names from 2004 become untraceable using online research. Fortunately most S&P 100 2004 companies are still around and fetching high yields.

The following described back test pooled, all available top ten yielding dividend payers from the S&P100 each year from 2004 forward to 2011 to document annual trades at their mid-June anniversary dates.

The "Dogs of the Index" Strategy Employed

Investopedia explains the strategic concept as "An investing strategy that consists of buying the 10 dogs of the dow [dogs of the 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."

This strategy is so simple, you don't need a committee to decide which stocks to buy each year because just two key metrics determine the yields that rank the index dog stocks: (1) Stock Price; (2) Annual Dividend.

Dividing the annual dividend by the price of the stock reveals the percentage amount by which each stock is ranked. After selecting a pool of forty stocks from the S&P100 index that throw dividend yields over 1.5%, the investor follows, trades, and awaits the results of an investment in the lowest priced, highest yielding one quarter of the pool. A third variable of broker commission of $10 per trade is deducted from every transaction to reveal net income in the scenarios below.

Using data from Yahoo Finance reveals the following portfolio of ten Dogs of the 2004 S&P 100 index:

For ease of calculation, a $1000 investment per stock is an easily divisible stake. Some investors prefer to pick five stocks by choosing all small, or all large Dogs defined by five stocks, with the lowest closing price being the year's small dogs of the index, and five with the highest closing price become the large dogs for the year.

Dogs in Play

For purposes of this back test, only the stocks falling off the list of top ten yields were sold and those coming on to the list as replacements were purchased in June of each year. The back test concludes by selling the whole kennel of ten stocks as of June 13, 2011.

The 2011 dogs are open for further review in June 2012 when results are known.

As you can see, five of the original ten S&P 100 Dog stocks listed in bold were still standing in the top ten at the conclusion of this back test. They are Altria (MO); AT&T (T); Southern Co. (SO); Bristol-Myers Squibb (BMY); Verizon (VZ). Two others, Exelon (EXC) and American Electric Power (AEP) started on the top ten, but fell off only to reappear at the end of the back test.

Extra income earned by an investor, when Altria (MO) spun off its Kraft (KFT) business unit in 2007 and Philip Morris (PM) in March 2008, is not included in the return reported in this back test. Gains from the base company were calculated by adding the gain from 2004 to 2007 to that obtained from 2008 to 2011. By using this method, Altria led all ten 2004 S&P 100 dogs with a net return of 90.12%.

The market driven wisdom of the dog investing strategy is demonstrated by American Electric Power (AEP). Purchased for $31.89 in 2004 and sold for $46.27 in 2007, (when the high price pushed AEPs dividend yield out of the top ten) and fetching dividends of $1.40, $1.40 and $1.46 per share those three years, AEP came back into the top ten in 2009 at $28.37 per share, and rose to $37.13 to conclude the test. Net return for AEP was 73.61% in two buys and concluding sales.

MO, AEP and three other companies showed net returns higher than the average 41.96% for the initial ten S&P 100 dogs over the seven year stretch. Bristol-Myers Squibb returned 66.14%, AT&T Corp returned 60.07%, and Southern Co returned 56.71% for the period,

Three companies showed below average, yet positive returns for the period. Verizon, despite remaining in the as the top ten for all seven years managed only a 28.58% return overall. Exelon came on to the list twice from 04 to 05 and from 2010 to 2011 to produce a 27.73% net gain while Texas Instruments returned 20.09% in only one trading year 2004 to 2005.

Two financial firms produced negative returns. JP Morgan Chase (JPM) lost (1.46%) on a $1000 investment in one year. However it took US Bancorp (USB) four years to lose (19.37%) on the same investment amount. USB points to the need for a stop loss signal in the Dogs of the Index investing strategy.

One available method is to exit the trade when a company announces reduced dividends. However, that strategy would have found an investor selling shares in February 2009 for $8.00 per share when USB announced a reduced quarterly dividend of $.05 from the previous $.425 per share. Holding the stock to sell on the June dog anniversary found the share price rebound to $17.95 to somewhat mitigate the pain.

Conclusion

This article described the performance of the initial portfolio of ten S&P 100 stocks. The following chart summarizes the performance of the initial ten from 2004 to the conclusion of the back test this June.

[Click to enlarge]


The starting ten Dogs of the S&P 100 2004 to 2011 fetched a juicy $5,035.65 net return or a 41.96% return on a $12k investment over five years (5.99% per year ), plus $240 to the broker. Note that two stocks, EXC and AEP were pushed off the top ten list once then repurchased upon their return to account for the $2000 of additional investment.

Trading only the top five original S&P100 dogs from 2004 (MO, T, EXC, SO, & BMY) would have returned $3,285.13 on $6k invested (due to EXC), or 54.75% with no losers, plus $120 to the broker for a net return of 7.82% per year.

The Dogs of the Index strategy is used to select suitable candidates from the S&P 100 index and trading them successfully has been demonstrated over this seven year back test from June 14, 2004 to June 13, 2011. The next article will describe the comings and goings of stocks selected and disqualified by yield for the S&P 100 list each June since 2005 to 2011.

Source: Dogs of the Dow Meet the S&P 100 in a 7 Year Back Test