The "Dogs of the Dow" is a strategy that selects the ten highest-yielding stocks out of Dow Jones Industrial Average (NYSE: DIA) which is rebalanced at the beginning of every year. An equal amount is invested in each stock in the portfolio. In essence, it's mean-reverting, as weak performers will naturally have higher yields, and strong performers will be filtered out. It also has the best likelihood of outperformance in years that interest rates trend lower.
Origins of Strategy
"Dogs of the Dow" was popularized by investment strategist Michael B. O'Higgin's "Beating the Dow," published in 1991. O'Higgins also launched http://dogsofthedow.com as a resource for anyone interested in details and updates. Over the last ten years, this strategy has modestly outperformed the Dow Jones Industrial Average. Much of the outperformance comes from higher yields and of course, this period involved a steep decline in short and long-term interest rates.
The basic concept behind O'Higgins' strategy is that for blue-chip stocks, the dividend is a better reflection of the company's prospects rather than the stock price which fluctuates based on sentiment and short-term trends. Therefore, "dogs of the dow" seeks to take advantage of discounts by scooping up blue-chips when stocks are at their cheapest based on their dividends.
2020 Composition
Although this list is subject to change as of December 26 close, the following ten stocks would make the cut: Exxon Mobil (NYSE: XOM) with a 4.97% yield; IBM (NYSE: IBM) 4.80% yield; Verizon (NYSE: VZ) 4.01% yield; Chevron (NYSE: CVX) 3.96% yield; Pfizer (NYSE: PFE) 3.87% yield; Cisco (Nasdaq: CSCO) 2.93% yield; Coca-Cola (NYSE: KO) 2.92% yield; Merck (NYSE: MRK) 2.67% yield; JP Morgan (NYSE: JPM) 2.62% yield; and Proctor & Gamble (NYSE: PG) 2.38% yield.
Notably, these yields are higher than the 10 year U.S. Treasury yield of 1.90%, and the 2 year Treasury yield of 1.62%. The portfolio is diversified but has some underperforming energy and defensive stocks. It also doesn't include the strongest performing stocks in the Dow like Apple (Nasdaq: AAPL) or Walt Disney (NYSE: DIS) which are less favorably valued based on the "dogs" logic.
This portfolio would probably underperform if 2020 is like the latter part of 2019, when nearly every bullish strategy is working, and overbought stocks simply become more overbought. Markets are moving higher despite higher interest rates, as it anticipates faster economic growth.
However, if 2020 subverts current expectations, then this portfolio would shine. Positive but decelerating economic growth with low inflation that leads the Federal Reserve to adjust its rate path to a more dovish trajectory is the ideal circumstance for these stocks.