In Fruitless Pursuit of the Dogs of the Dow - Brief Article

Kiplinger's Personal Finance Magazine, April, 1999 by William Giese

Hip and savvy investor that I am, I decided last fall to outfox the stock market, anticipate the dogs and make money on CAT.

CAT is the ticker symbol for earthmover manufacturer Cater pillar, whose stock is one of the 30 that make up the Dow Jones industrial average. CAT's yield then was a fat 2.2%--enough, I figured, to make it one of the Dogs of the Dow for 1999. In case you slept through the last decade, the Dogs of the Dow are the ten highest-yielding Dow stocks. Here's the deal: A high yield often means that problems have depressed a stock's price. But these bowwows usually fix what's wrong, so the price floats up and the yield settles down. A disciplined investor can buy the ten dogs at the start of each year, hold them that year and then switch to a new pack of barkers. Historically, the dogs return on average five percentage points per year more than the Dow 30.

Money manager Michael O'Higgins first publicized the Dow-dog theory years ago in his book Beating the Dow. Canine-investing variations eventually included several on the Motley Fool's Web pages. These days it wouldn't surprise O'Higgins if something like two million people are investing $20 billion using Dog strategies.

FRIGHTENED AWAY. So I figured that if I bought Caterpillar in late 1998, two million optimists would follow me into CAT once it made the '99 list and drive up its price. But events took an unexpected turn. CAT had an earnings scare in December, the stock dropped and I got spooked, even though CAT pogoed right back up again. Pure dumb luck may once again have saved my hide because I then did what I should have done in the first place: look carefully at the numbers.

I can now report that Dog results have been what you might call disappointing (see for yourself at www.dogsofthedow.com). From 1994 through 1998 the Dogs of the Dow got beaten every year but one by the Dow Jones industrial average. The past two years, the Dogs have been beaten by Standard & Poor's 500-stock index, too. A variation of the basic Dogs list--using the five cheapest stocks among the ten Dogs--got similarly wiped.

The Dog-friendly Motley Fool organization has devised many such variations. As I understand it from the explanations at www.fool.com, the Motley Fool started with a special Dog twist that involved dropping the very cheapest of the five cheapest Dog stocks and doubling up on the second-cheapest stock. The Foolish Four strategy did great in 1996. In 1997 it did pretty well, too, but lagged the bellwether S&P 500. Somebody started tinkering and there was a creative explosion on the Motley Fool's message board, giving birth to such variations as the Foolish 2, Foolish 4*, Foolish 4 Plus, Foolish 9 and Old Foolish Four. I'd bet that the results of all these systems are outstanding when compared against historical stock data.

But they all got beaten in 1998 by both the S&P 500 and the Dow. And this year the Motley Fool introduces its newest formula, which involves, uh, dividing the yield by the square root of the stock price.

TOO MUCH DOG? I'm scratching my head over all this dividing of dog yields by canine square roots. I mean, hasn't the game changed and won't all historical dog results be less meaningful? After all, two million Dog investors are doing something they weren't doing just a few years ago, and I suspect that this technique is becoming skee-wiffed.

Meanwhile, Michael O'Higgins, sire of the Dogs, has written a new book, Beating the Dow With Bonds (HarperBusiness, $24). Over lunch the other day, he said the problem with all the Dogs of the Dow approaches is that they are too popular to work--done in by their own success. "Dogs is a contrarian strategy," O'Higgins explains. "In order to be a successful contrarian strategy, it's got to be out of favor."

Now I get it. They're show dogs that no longer hunt.