Beware The Dogs of The Dow

Canadian Shareowner, May/Jun 1998

Equity investors thinking about an investment strategy involving the Dogs of the Dow may want to reconsider. New research suggests that there may be no benefit to adopting such an approach.

The Dogs of the Dow strategy involves buying the 10 highest yielding stocks in the Dow Jones Industrial Average of 30 stocks, holding them for a year and then replacing those stocks whose dividend yield has fallen out of the top ten. Proponents of this strategy point to the fact that the returns of the Dow Dogs portfolio have been significantly higher than those of the Dow 30.

But in a recent study published in the Financial Analysts Journal researchers found that when differences in risk, transaction costs and taxation are considered, the Dogs of the Dow strategy does not outperform the Dow 30.

For the post-war period 1946 to 1995 the study found that the Dow Dogs had an average annual return of 16.77% compared to 13.71% for the Dow 30, a difference in gross investment returns of 306 basis points. The study also found that the Dow Dogs portfolio had higher risk and more transactions costs than did the Dow 30 portfolio due to less diversification and a higher turnover rate. The higher turnover rate also triggered more frequent payments of capital gains taxes, leaving investors with less money for reinvestment and compounding. Adjusting for these differences, the researchers concluded that there was a negligible difference in the two portfolios average net investment returns.

The study's analysis of subperiods raises even more doubt about the Dogs of the Dow strategy. As the graph shows, the Dow Dogs beat the Dow 30 in only 2 of the 5 subperiods. In the most recent subperiod the Dow Dogs underperformed the Dow 30 by 122 basis points, leading the researchers to suggest that broad investor awareness of the Dow Dogs strategy may have eliminated any market inefficiencies that existed in the past.