Investing

This old-school investing strategy 'hasn't been in fashion' in recent years. Now it's beating the S&P 500 by 19 percentage points

The classic "Dogs of the Dow" strategy has come up short lately. But over longer periods, buying the highest-yielding stocks in the Dow has been a winning strategy.

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Key Points
  • The "Dogs of the Dow" strategy prescribes buying the ten stocks with the highest dividend yields in the Dow Jones Industrial Average at the beginning of each year.
  • So far in 2022, the Dogs are down less than 1% compared with a nearly 20% slide in the S&P 500.

When markets are hot, investors sometimes tend to eschew tried-and-true strategies in favor of hunting for the next big thing. But markets are cyclical. And when things finally come back around, it can be a swift reminder that the classics are classics for a reason.

Take the so-called "Dogs of the Dow" strategy, which focuses on high-dividend paying stocks in the Dow Jones Industrial Average. So far this year, had you built a portfolio based on this old school rule, you'd be down less than 1%, compared with a 13.5% slide in the broader down and a nearly 20% dip in the S&P 500.

"It hasn't been in fashion since late last century, but it may make sense to start thinking about the Dogs of the Dow," says Robert Gilliland, managing director and senior wealth advisor with Concenture Wealth Management. "We may be entering a period where dividends, and companies with the ability to continue paying dividends, are important."

Here's what you need to know.

Buying 'Dogs' is a kind of value investing

Here's how the Dogs work. At the beginning of the year, invest in the 10 stocks in the Dow Jones Industrial Average with the highest dividend yields — those that provide investors with the highest monthly cash payouts relative to their share price.

Hold for a year, rinse, repeat.

These stocks likely sport high yields due to declining share prices, the thinking goes. And because the Dow purports to hold high-quality, blue-chip companies, these resilient stocks are likely to bounce back while providing ample dividend income to boot.

The Dogs of the Dow is a value investing strategy — one in which the investor seeks to purchase shares trading at bargain prices. If the term rings a bell, that's because it's practiced by some rather well-known investors. If you haven't heard of the godfather of value investing, Benjamin Graham, you've certainly heard of his most famous disciple: Warren Buffett 

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How dividends can help in choppy markets

During volatile periods in the stock market, investors tend to like large companies that offer generous dividends for two reasons, and one is purely mathematical: Dividends account for a large portion of the return stocks provide for investors. From 1930 through 2021, reinvested dividends contributed 40% of the return of the S&P 500, according to data from Hartford Funds.

When markets are headed up, that extra bit of cash can act as a booster to your return. If a stock you own appreciates 7% in price and offers a 2% dividend yield, you've earned a 9% return. Conversely, a payout can act as a cushion when prices are falling, points out Gilliland.

"If you buy a company that doesn't pay a dividend, and the stock goes down 10%, you're total return is -10%," he told Grow. "But if it pays 3%, assuming taxes aren't an issue, you're getting -7% because you're receiving that income."

Beyond that, a consistent dividend payment program can be a sign that a company has the financial strength to withstand difficult times, says Eric Diton, president and managing director of The Wealth Alliance.

"There are plenty of bad companies out there, and you can manipulate things like earnings pretty easily. But you can't fake cash. Cash is king," he told Grow, "If you're not making money, you're not going to have the cash to pay dividends over time. If a company pays and consistently raises its dividend, it's not a guarantee, but you can be much more confident in the fortitude of that company."

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How to add high-quality dividend payers

The Dogs of the Dow is a sort of shortcut when it comes to finding firms with high yields and sustainable dividends. Picking the highest yielders in the index means that you're almost certain to get an above-average payout. As a group, the Dogs currently yield 4.1% compared with a 2.5% yield for the Dow and 1.6% for the S&P 500.

And high quality firms are assumed to be table stakes when it comes to the Dow — an index constructed by a committee in the hopes of finding a group of companies leading the U.S. economy. Indeed, no matter which firms make the Dogs in a given year, you're likely to come across a slew of multinational names you recognize.

But just because a stock is in the Dow doesn't make a stock or its dividend invincible. Any individual stock that you add to your portfolio is worthy of scrutiny, experts say. Companies paying out a large portion of their earnings in the form of a dividend are potential red flags, as are firms that are heavily indebted.

It's also worth noting that the strategy follows just ten stocks selected from an already thin portion of the broad stock market, says Charles Rotblut, vice president of the American Association of Individual Investors.

"If you're looking for a dividend strategy, there are plenty of exchange-traded funds that give you a much broader slice of the stock market," he says.

Before buying any dividend ETF or mutual fund, be sure to check the fund's prospectus to see what kind of financial criteria are used to add stocks to the portfolio.

The views expressed are generalized and may not be appropriate for all investors. Past performance does not guarantee future results. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.

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