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Triggered by yield, a trading system called the "Dogs of the Index" can be used to determine the best of the best dividend stocks. The dogs system empowers investors with all the wisdom and knowledge of well-paid wizards of investment and publishing for free, as those investors annually select the highest yielding and lowest priced constituents in a collection of equities built by experts.

This article reports results for a Defensive Sector Index as of October 12. This index was cobbled together by screening three lists of companies with market caps over $5 billion: (1) Morningstar's Consumer Defensive Sector (ConDef) list, (2) YChart's Utilities Sector (Utility) list, and (3) YChart's Healthcare Sector (Health) list. Seventeen of the highest yielding dividend stocks from each of those three lists were analyzed using a once-per-year trading system triggered by yield, called the "Dogs of the Index," to determine the 10 best of the best of these 51 Defensive Sector Index stocks.

Comparative Methods Used

Market performance of these 51 selections was then reviewed using six months of projected annual dividend history from Yahoo Finance, along with annual divided projections adjusted for market realities.

Two key numbers determined the yields to rank the stocks in each index: (1) stock price and (2) annual dividend. Dividing the annual dividend by the price of the stock declared the percentage yield by which each dog stock was ranked.

Dogs Of The Index Metrics

Historically, dividend dog investors utilized this ranking system to select portfolios of five or 10 stocks in any one index, sector, or survey to trade. They awaited the results from their investments in the lowest priced, highest yielding stocks and prayed that the price of every stock they now owned climbed higher (having locked in a high yield percentage at purchase).

This Dogs of the Index strategy, popularized by Michael B. O'Higgins in the book "Beating The Dow" (HarperCollins, 1991), revealed how low yielding stocks whose prices increase (and whose dividend yields therefore, decrease) could be sold off once each year to sweep gains and reinvest seed money into higher yielding stocks in the same index.

Investment Wisdom From The Defensive Sector Index Dogs

Listed below are the 51 Defensive Sector Index stocks by yield as of 10/12/12, per Yahoo Finance data. A recent Seeking Alpha article by David Hunkar touted a different loose collection of these defensive dogs, stating:

Defensive sectors outperform over the long-term due to the compounding effect of dividends and stable growth, and they are also relatively less affected by economic cycles. For example, regardless of the state of the economy, consumers buy food, toothpaste, drugs and use electricity, [cigarettes], etc. Companies operating in the sector are usually well-established and have strong cash-flows which helps to make consistent dividend payments and also dividend increases occasionally.

Six of the top 10 stocks in this index projecting the big dividend yields as of October 12 were utility sector firms. CPFL Energia (CPL) led the top 10. The lone healthcare dog, AstraZeneca Group (AZN), preceded the top consumer defensive dog in third place, Reynolds American (RAI). Two more ConDef stocks hit the top ten: Lorillard (LO) and Altria Group (MO). The balance were all utilities: National Grid (NGG), Exelon Corporation (EXC), Ameren Corporation (AEE), FirstEnergy (FE), and PPL Corporation (PPL).

Dividend Vs. Price Results For Defensive Dividend Dogs

Below is a graph of the relative strengths of the top 10 defensive sector index stocks by yield as of October 12, 2012. Projected annual dividend history from $1000 invested in the 10 highest yielding stocks each period and the total single share prices of those 10 stocks created the data points for each of the past months, shown in green for price and blue for dividends.

(click images to enlarge)

Conclusion: Defensive Dogs Got Bearish Since July

January to July, defensive dog components showed the projected annual dividend from $1000 invested in each of the top 10 defensive dog stocks dropped 7% as the aggregate single share price for those 10 rose 44%. However, since July, the aggregate single share price for top 10 defensive dogs declined 11%. Furthermore, the dividend from $1000 invested in each of the top 10 also showed a bearish turn as it rose nearly 4%. Overall January to October, projected dividend dropped nearly 4%, while price gained over 28%.

Conclusion Two: Analysts Forecast October 2013 Net Gains Up To 14.92% For Defensive Dividend Dogs

Top 10 dogs for the defensive components list were graphed below to show relative strengths by dividend and price as of October 12, 2012, and those projected to October 12, 2013.

Historic prices and actual dividends paid from $1000 invested in the 10 highest yielding stocks and the aggregate single share prices of those 10 stocks created the data points for 2012. Projections based on estimated increases in dividend amounts from $1000 invested in the 10 highest yielding stocks and aggregate one year analyst mean target prices as reported by Yahoo Finance created the 2013 data points -- green for price and blue for dividends.

For the coming year, Yahoo Finance projected a 10% lower dividend from $1000 invested in each stock within this group, while aggregate single share price for the 10 was projected by analysts to increase by 12%.

Seven highlighted probable profit generating trades one year from now revealed by the Yahoo analyst mean target price were:

CPFL Energia, netting $469.78 in October 2013 based on mean target price set by one analyst.

Lorillard, netting $239.89 in October 2013 based on mean target price set by 10 analysts.

Exelon Corporation, netting $214.28 in October 2013 based on mean target price set by 16 analysts.

Reynolds American, netting $134.36 in October 2013 based on mean target price set by 10 analysts.

Altria Group, netting $129.76 next October based on mean target price set by 11 analysts.

AstraZeneca Group, netting $86.00 in October 2013 based on mean target price set by three analysts.

National Grid, netting $70.70 in October 2013 based on mean target price set by two analysts.

The resulting October net gain projected from dividends and swept price gains was $14.92% from $10000 invested, according to analyst estimates.

Stay tuned for periodic updates on how well or whether projected gains for 2013 hold. A companion article demonstrated how to select a kennel of 10 defensive dividend dogs based on net gains to net up to nearly 24% in the coming year. Look for "Playing with Defensive Dividend Dogs for 24% Net Gains" here on Seeking Alpha.

Disclaimer: This article is for informational and educational purposes only and should not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security. Prices and returns on equities in this article except as noted are listed without consideration of fees, commissions, taxes, penalties, or interest payable due to purchasing, holding, or selling same.

Source: Introducing Defensive Sector Top Dividend Dogs