Dogs of the Dow

The Dogs of the Dow is one of my all-time favourite strategies. In fact, it’s a bit like an old Labrador, unfailingly loyal and it rarely disappoints.

The only problem is it’s so simple many investors quickly discard it because they believe something so simple could not possibly out-perform the market. But it does.

Welcome to deep dive number three. This deep dive explodes the recently evolved myth that blue chip stocks are an over-rated and under-performing asset class. They’re not.

Here’s why.

Firstly, and for the uninitiated, the Dow Jones Index is the leading indicator of how stocks are performing on Wall Street (New York Stock Exchange). Amazingly, even though Wall Street has tens of thousands of stocks listed on its exchange, the Dow is only made up of the top 30 stocks.

Got that, 30 stocks only!

Now, for the dogs.

The Dogs of the Dow strategy is very simple. Suppose you have $10,000 to invest, all you do is invest $1,000 in each of the bottom 10 stocks of the Dow Jones Index and hold them for one year. At the end of that year, you sell them and then buy whatever are the bottom 10 stocks the following year. That’s it. Simple.

Does it work?

Yes. Testament to its simplicity and power, the 2016 Dogs of the Dow finished up 10.5% at June end while the Dow Jones Index ended up only 2.2% for the same corresponding period. (Source: Forbes Magazine) I.e. The Dogs beat the Dow by 8.3%.

Not bad for a bunch of dish lickers!

Oh, and BTW, all these stocks are blue-chip. This strategy does not involve swinging for the fences and taking any unnecessary risks with a bunch of penny dreadfuls.

History is proof positive blue-chips always stand the test of time. Do you remember Y2K?

Old Dogs and New Tricks

When the dot.com boom reached stratospheric heights in the late nineties, early naughties, the belief was we were going to transition from the ‘old’ economy into the ‘new’ economy. Bricks and mortar businesses would be replaced by clicks and mortar enterprises and anyone who continued investing in ‘old’ style stocks such as banks, retail, and infrastructure was just a numpty. A complete Neanderthal.

And then the dot.com boom busted and everyone went back to blue chip stocks – banks, retail, infrastructure, etc. The dogs were back in vogue because the new tricks didn’t work.

And sixteen years later, nothing has changed.

Recently there have been a few fund managers running around town talking down blue-chip stocks. Their general thesis is that blue-chips are no longer blue chips because they haven’t out-performed in a flat market. Not surprisingly, these same blokes run funds made up of mid-cap stocks, not large caps (or blue chips). They’re trying to spook everyone out of blue-chips into green chips.

To put this spruiking into perspective, ignoring blue-chip stocks is like throwing your straw hat out in winter because it doesn’t seem to be doing its job and then buying it back in summer. Everything cycles.

However, these fund managers provide a valuable lesson…

Big or Small?

Let’s think of stocks as people.

A small cap stock is like an infant – cute, very attractive and in relative terms, and doesn’t require large cash outlays.

A mid-cap stock is like an adolescent – starts to blossom, shows lots of promise but also has a mind of its own! Not surprisingly, they require bigger cash outlays than the infants.

Large cap or blue-chip stocks are like adults – hopefully they’ve matured and settled down a bit and generally have a much clearer direction on where they’re heading. However, they require larger cash out-lays but they’re generally more predictable too. They also have the ability to generate reliable income (dividends), and lots of it.

Get my drift?

Building Your Own Dog Kennel

The Dogs of the Dow strategy is incredibly simple. Most importantly, this strategy generates above average returns without taking unnecessary risks. There will always be risk but at least a strategy like this helps mitigate that risk considerably.

Equally, you don’t have to invest in the Dow Jones Index to generate these sorts of returns. Recently we have been putting some of our clients into similar funds with yields of 8%, 10.5% and 15.5% using a very similar strategy to Dogs of the Dow. It’s nothing new and it doesn’t rely on the markets going up. The power is in the strategy, not the stocks.

And if some of the fund managers around town think these funds are dogs, I’ll happily take a big kennel full of them any day. And so will our clients.

Blue is best and big is beautiful.

Have a great weekend!

Adam

P.s. there will be no Moowsletter next week.