Dogs Of The Indices Training 2011: 6 Wins Vs. 12 Losses

by: Fredrik Arnold

Over the years, many investment strategists have recommended dividend paying stocks. How do you know which dividend stock is good, better, best, bad or ugly? One way is to back test using historic pricing and dividends. Since March 2011 I have been writing about the virtues and pitfalls of chasing dogs of the index stocks for fun and profit.

Dogs of the Indices

The dogs of the index strategy is my own expansion on the dogs strategy popularized by Michael B. O'Higgins in Beating The Dow (HarperCollins, 1991). Using this strategy, low yielding stocks whose prices increase (or whose dividends decrease) are sold off once each year to sweep gains and reinvest the seed money into higher yielding stocks in the same index. 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 declares the percentage yield by which each dog stock is ranked. Thus, having selected their portfolios of five or ten stocks in any one index, investors are able to follow, trade, and await the results from their investments in the lowest priced, highest yielding stocks selected.

Since June I have reported monthly about the stock yields and prices of eight indices. As of November I ranked those indices by risk thus:

Russell & Sector Buys

On November 29, 2010, I started a test account with $20.043.12 of my life partner's savings. This money was invested in 18 high yielding dividend stocks selected from the Russell and Sectors indices, projected to yield between 19.03% and 7.57% per year. Instead of investing as close to $1000 in whole numbers of shares in each of 20 stocks, I chose to invest as close to $2000 in each of the top yielding two of 18 stocks plus as close to $1000 invested in each of the remaining 16 stocks. It seemed like a good idea at the time. The test was, after all, driven to capture high yield. Here is the resulting list by yield:

Click to enlarge

Now that a year has passed since this very real and agonizing forward test that began with my wife's hard won savings, the results are now available to report. These are unvarnished actual buy and sell gains and losses as of the dates shown. (That is, the numbers are not adjusted for dividends and splits though the data is as reported by Yahoo Finance.) Thirteen Russell and five Sector Index stocks were purchased.

Six Winners

Of the eighteen stocks purchased, six combined their price gains and dividends to more than pay for broker fees by $1,398.21 as of 12/2/11. Five were from the Russell and one was from the Sectors index. The one from the Sectors index showed the most net income accounting for more than half the total gains due to a merger as of March 30, 2011. The chart below displays the winners ranked by gains.

Click to enlarge

Twelve Losers

Eight Russell plus four Sectors index stocks combined to lose a total of $2,422.38 more than broker fees in this eighteen dog stock portfolio. The top three losers, TNK, HIMX, and CHKE, combined to cause more than half the loss. The chart below displays the losers ranked by loses with the biggest losers at the top.

Click to enlarge

Here are the combined results of Russell & Sectors winners from top to bottom by gains:

Click to enlarge

Dogs of the Indices Training 2011

The primary lesson learned from this recent single year back test reinforces the cases I wrote about in March and April, 2011, in answer to the question, "Can Dividend Yields Predict Net Returns?" The answer in December is the same as I learned in April-- "NO"! In fact, a nearly inverse relationship between dividends projected and net gains achieved by an index was revealed: In the March / April test, the index that showed only modest dividend yields and whose actual dividends were less than projected still managed to blow away the field with annual net returns of 24.87%.

Guess in which index I'll be investing the remaining funds from this test?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.