DOGS OF THE DOW
by Robert Coplan, Robert J. Garner, Editors
Ernst & Young Financial Planning Reporters
Some stock investing strategies turn out to be mostly bark
and little bite. But the stock picking methods collectively known as the
"Dogs of the Dow" strategies have historically provided steady
performances that cause some to refer to them as "an investor's best
friend."
The Dogs of the Dow techniques are variations on the time-honored
strategy of value investing: You buy stocks of high-quality companies that
are presently out of favor and potentially undervalued with the potential
for future price appreciation. For Dogs of the Dow strategies, the stock
universe is limited to the 30 companies listed on the Dow Jones Industrial
Average.
A Few of the Permutations
One of the best-known versions is the Dow 10. You invest
equal dollar amounts in the 10 highest-yielding stocks of the Dow 30. Then,
once a year, you adjust your portfolio so that you are equally invested
only in the 10 highest-yielding stocks of the Dow 30 each year.
The Dow 5 is another well-known method: From the 20 highest-yielding
stocks of the Dow 30, you invest only in the five with the lowest share
prices. You then adjust your portfolio annually based on the same criteria.
Numerous other renditions exist. The Dow 4, for example,
eliminates the lowest-priced stock from the Dow 5. And the Dow 1 involves
investing only in the second-lowest-priced stock in the Dow 5.
Intriguing Track Records*
Despite the simplicity of the concepts behind the strategies,
the long-term performance records for the Dow 10 and Dow 5 are impressive.
Consider, for example, the average annual total returns for periods ending
December 31, 1996. They both beat the Dow 30 and the S&P 500 for the
five-year period.
Shorter-term results tell a different story. For example,
the Dow 30 was the victor for the three-year period and for 1996 -- just
barely edging out the Dow 10 in both cases. And as of November 18, 1997,
the year-to-date price changes (excluding dividends and commissions) were
"neck-and-neck" as follows: the Dow 30 (i.e., the stocks in the
index at 12/31/96) was at 19.2 percent, the Dow 10 at 19.7 percent, and
the Dow 5 at 19.2 percent. These shorter-term results help to emphasize
that the dogs of the Dow techniques, like other methods of value investing,
are best used as long-term strategies.
Also bear in mind that the dogs of the Dow methods allow
for limited stock diversification. Therefore, it is only appropriate for
a portion of a portfolio under asset allocation models. As with other stock
picking strategies, unless you are devoting significant assets to the method,
you will need to limit the number of stocks acquired (e.g., by opting for
the Dow 5). Also, certain brokerage firms offer unit trusts that can facilitate
your interest in following one of these strategies if you are only devoting
a few thousand dollars to it.
And in light of the new tax rules regarding capital gains,
bear in mind that the usual "dogs" systems of buying and then
rebalancing after one year will now generally result in a 28 percent tax
rate on gains. You would need to have a buy-and-hold cycle of longer than
18 months in order to benefit from the reduced 20 percent tax rate on capital
gains.
Editor's Note: Robert B. Coplan
and Robert J. Garner are editors of the Ernst & Young Financial Planning
Reporter, 1 year, $96. Visit Ernst & Young's Personal Financial Counseling
Web page at: www.ey.com/pfc
*Source: Track Records and 1998 Dogs of the Dow (http://www.dogsofthedow.com) | 
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