During the 4th quarter of each year I whip out my calculator and determine the five stocks that will constitute the Dogs of the Dow for the upcoming year. As you know, the Dogs of the Dow are those stocks from the thirty that make up the Dow Jones Industrial Average which have the highest dividend at the end of the year.
In theory, the stocks with the highest dividends are the ones that have grown the least (thereby having a high dividend) and are consequently poised to outperform others in the group. In other words, a stock pays a high dividend oftentimes because the stock price is low - therefore resulting in a higher yield. For example, Intel INTC for several years was priced in a range of 27 to 29. At a price of say 28, the yield was 3.2%. However now that the price of the stock has decreased, the same payout produces a higher yield. Intel is now at 20.80/share and the new yield is 4.3%.
This is a very interesting and often successful method of stock picking for a number of reasons:
1) By limiting your prospective stocks to members of the DJIA, you are selecting from a group of solid, well run, blue chip, companies that have been around for years. Not only are they relatively safe stocks, but they generally trade in high daily volumes due to their being included in numerous index funds and ETFs.
2) By selecting the highest paying dividend stocks you are, obviously, benefiting from a relatively high dividend. That dividend payment will ordinarily contribute significantly to the bottom line and overall return of that stock. For example, if you bought Intel at 20.80 and over the year it increases to 24, you would have roughly a gain of 15.3% PLUS the dividend of 4.3% producing an overall gain of almost 20%.
3) As the price of a stock increases, its dividend yield decreases (until the dividend itself is increased). Since an unusually high dividend would be considered an anomaly for it to move back towards the average, the price of the stock would have to increase. Whether this is a product of the "invisible hand" or simply a result of buyers being attracted to the high dividend, it does not matter.
So now that we have the theory established, what are the five Dogs of the Dow for 2013, as calculated in mid-November, 2012?
1) AT&T T is currently priced at $33.34 with a 5.25% yield
2) Verizon VZ is priced at $42.64 with a 4.83% yield
3) Intel is priced at $20.80 with a 4.33% yield
4) DuPont DD is priced at $43.34 with a 3.97% yield
5) Hewlett-Packard HPQ is priced at $13.61 with a 3.89% yield
With these five stocks as your starting point, you would begin your research and decide whether any of these Dogs of the Dow should be added to your portfolio. With all the problems of Hewlett-Packard I would avoid it, and with AT&T and VZ being direct competitors I would select one or the other and not both.
Finally, the Dogs of the Dow can serve as a wonderful source to look for equities to build the core of your portfolio as discussed here.
Purists of this theory would require that you calculate and determine the Dogs of the Dow on the last trading day of the year and purchase on the first trading day of the new year.
Disclosure: I am long 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.