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In 1602 a Dutch company instituted the practice of issuing ownership shares in the company in exchange for capital needed for expansion.  The practice caught on and in 1611 the world’s first stock exchange was formed in Amsterdam.

Approximately 15 minutes after the market opened for business, some Dutch math wizards began a search that was to last for centuries – the search for a programmable trading strategy to guarantee profitability in the market.  By programmable we mean an automatic strategy that would click into place without the need for long and boring analysis on the part of the buyer.  Pick a few numerical values and when the share price hits the predetermined value, you buy.

In bygone days the average retail investor did not have access to the same information as the favored and well-connected professional investor, fueling the quest for the perfect auto-buy strategy.  Even with the advent of accessible information, these strategies still abound.

A favourite of many – still in use today – is the “Dogs of the Dow” investment strategy.  The strategy originated in 1991 in the United States (where else??) and was spelled out in a book called Beating the Dow, by Michael O’Higgins.  His basic idea was that the cyclical nature of both business and the markets led fundamentally sound stocks beaten down in one year to rebound in the next.  He used dividend yield to measure the severity of the beating and back-tested the strategy and announced to the investing world that from 1973 to 1989 the Dogs returned 17.9% while the Dow returned only 11.1% in that time.  As far as programmability goes, it is hard to beat the simplicity of the Dogs of the Dow.  Here is how it works.

As originally conceived, on the first trading day of a New Year the investor takes the top ten highest dividend yield stocks from the Dow and invests an equal amount in each.  You hold the stocks for one year and one day – for tax benefits of long term gains – and then again list the top ten highest dividend yielding stocks.  The stocks from your first list that do not appear again are sold and replaced by the new entrants.  The sell and replace program guarantees a return on the shares that have rebounded, allows more time for the non-performers to improve, and adds fresh meat to the portfolio to ripen over the coming year.

For investors pressed for time, this approach takes a few hours per year.  The Dogs of the Dow attracted respected mutual funds and institutional investors when introduced.  The strategy made its way to Australia as the “Dingoes of the ASX 50”, and alternatively, as the Aussie Dogs.

Here then is a table of Dingoes of the ASX or Aussie Dogs for the start of 2012.

CompanyCodeDividend YieldP/E Ratio
QBE InsuranceQBE10.01%10.5
Westpac BankingWBC7.69%10.09
National Australia BankNAB7.59%9.43
APA GroupAPA7.58%22.79
Bendigo & Adelaide BankBEN7.36%9.19
Macquarie GroupMQG7.07%9.32
Australia/New Zealand BankANZ6.72%9.92
WestField GroupWDC6.69%13.22
Commonwealth BankCBA6.51%11.23
ASX LimitedASX6.03%15.02

 

If you have $1,000 to invest, you buy $100 worth of each of the ten dingoes and relax and wait for a year.  Sound too good to be true?

Despite what we consider to be a fatal flaw present at the beginning, the strategy not only caused brokerage houses at the time to offer tracking vehicles to see how your doggie portfolio was doing throughout the year, it spawned several variations and remains in vogue today.  

So what is the flaw?  As you know when share price goes down and the dividend payout remains constant, the yield goes up.  In theory then, higher yields indicate distressed share price with a management that believes the company will rebound as evidenced by maintaining the dividend.  Companies in real trouble would cut the dividend, lowering the yield.  

In practice, however, there are capital intensive industries that pay low dividends to begin with in order to invest in growing the business.  In tough times, companies like these would rather cut the dividend than cut capital investment.

The Aussie Dogs are a perfect example.  In the list above, nine of the ten are financials.  Do you see any resource companies there?  And isn’t it Australia’s abundant natural resources that have fueled our growth?  Companies like BHP, Rio, and Fortescue Metals would rather expand than pay higher dividends.  

And there is another flaw which escapes the attention of many.  Once upon a time, dividend paying shares were the most attractive vehicle for investors; but then the boom in growth stocks began.  Apple and Google, two of the world’s largest companies, do not pay dividends.  In short, you would never find stellar companies like BHP, RIO, or APPL on a doggy list.

You may have heard the proverb:  the proof of the pudding is in the eating.  So the question here is does this strategy work.  As strange as it may seem, that depends on where you go to answer the question.  You will find statements that the Dogs outperformed, but these claims reflect long periods of time.  Search for yourself and you will find ample evidence of single years or a string of three or four years where the dogs failed to outperform.

However, the fact that, for whatever reason, a doggy portfolio can do well if the time frame is long enough keeps the Dogs of the Dow strategy alive and barking.  For investors unable or unwilling to invest in ten dogs, there is the puppy dog strategy -the Small Dogs of the Dow with only five dogs to buy. There is a even a website, dogsofthedow.com, dedicated to the care and feeding of investors who adhere to this strategy.  

Despite the fact that critics are cite the off-years of doggy performance as proof the strategy’s success has been due to mere chance, proponents remain.  Some argue with merit that the Dogs and Dingoes strategy is a value approach and the market has favoured growth shares over the last decade and more.  The dogs will have their day, and maybe they will.

Yet when you boil it all down to the basics, at best, the Dogs of the Dow will allow you to outperform an index performance, which is by definition, an average performance.  If you want your investments to do substantially better than average, do you really want to leave them to the dogs?

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