Teaching the Dogs a New Trick

A popular income-oriented investment strategy gets a little boost from S&P research

Investors who are interested in income from their portfolios are often told to follow the Dogs of the Dow theory, where you buy the 10 highest-yielding stocks in the Dow Jones industrial average.

The only problem is that if you followed this advice for the past few years, you probably lost money. The Dogs of the Dow is less of a purebred and more of a mutt. In 2005, the aptly named Dogs fell 8.9%. In 2004, they posted only a 4.4% gain. In 2002, they were down 8.9%, following a 4.9% decline in 2001. Of the past five years, only 2003 stood out as a good year for the Dogs; they were up 28.7%.

We think it's time to teach these Dogs a new trick. The whole reasoning behind the Dogs of the Dow theory is that you get a combination of capital gains and dividend income. But too often, these stocks do not post capital gains at all.

We overlaid S&P STARS rankings on the Dogs of the Dow, to come up with some recommendations. As you can see from the accompanying table, with the S&P overlay, only five of the Dogs pass muster. That's up from four at the beginning of 2005.

In general, S&P expects investors to begin rotating their investments out of small-cap and speculative issues and into larger-cap, high-quality names. While the ability to pay out a regular dividend is certainly one measure of high quality, it is not the only one. In fact, the S&P 500 Growth index has 89 stocks with above-average Quality Rankings, whereas the S&P 500 Value index has only 62. Savvy investors will continue to search for good investment opportunities in both the growth and value universes.

  Dogs of the S&P
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