THE DOGS OF THE DOW

QUESTION 1

The Dogs of the Dow is a stock picking investment strategy that is based on the dividend yields of the 30 stocks that make up the Dow Jones Industrial Average (DOW). Based on this strategy, after the stock market closes on the last day of the year, an investor is supposed to select the ten stocks with the highest dividend yield from the list of the 30 stocks that make up the Dow Jones Industrial Average. Subsequently, he/she invests an equal dollar allocation in each of ten high dividend yield stocks. The Dogs of the Dow strategy aims to outperform the market’s performance by buying 10 undervalued blue-chip stocks. These stocks are undervalued, given that they offer high dividend yields. The high dividend yields is an indication that they are in a position to generate returns (dividend) for the investor. This raises the other rationale, which is that there is a possibility that they are undervalued since their high dividends returns is not reflected in their relatively low share price.

The strategy is made more effective by the fact that the 30 stocks that make up the Dow Jones Industrial Average represent the country’s largest, most liquid, and well-reputed companies that have had long-term sustainable growth. This means that they represent the main industries and general economic condition of the country. As a result, any sector concentrated risks raised by any individual industry are eliminated through diversification. Therefore, investors are in a position to reach the objective of attaining higher returns while having low-risk exposure considerably.

On the other hand, Small Dog is an investment strategy for investors aiming a beating the performance of both the market and the Dogs of the Dow strategy. While it carries a high rate of expected returns, it also has a higher rate of risk compared to the Dogs of the Dow strategy. Under the small dog’s approach, an investor selects five stocks with the lowest price from the 10 Dogs of the Dow. These five are the small dogs, and upon selection, the same investment procedure used in the Dogs of the Dow strategy is applied here.

Dividend yield is the financial ratio that shows how much a listed company pays out to shareholders as dividend each year relative to the market value per share. It is calculated by taking a share’s indicated dividend (last quarterly dividend) multiply by four then dividing it by the existing share price. As such if a share’s price increases at a rate higher than its dividend, the yield falls. To investors, this is an indication that the stock price is ready for a drop.

At the same time, in case the dividend yield rises sustainably the stock price may be poised for an increase. This is how a high dividend yield can be an indicator of the undervaluation of a stock. This is because the high dividend yield attracts value investors. These investors start purchasing the stock of the company; the increase in demand for the share causes the denominator (price) in the dividend yield’s formula to increase. This pushes the ratio downwards. The decline in dividend yield causes the value investors to start selling their stock holdings since it is no longer an attractive investment based on a dividend-yield approach. The drop in demand as investors exit their positions causes a drop in price, and once again the dividend yield starts increasing. This makes it an attractive option to value investors. Once again, the price of the share increases.

It is as a result of these cycles of price increase that a high dividend yield might indicate the undervaluation of a stock. However, it should be noted that the high dividend yield should be sustainable and historically significant for it to indicate an undervaluation of the stock concerned.

QUESTION 1

The tables below represent the Dogs of the Dow and the Small Dogs for the year 2013.

Table 1. Dogs of the Dow from Feb 1^st, 2013 and Feb 3^rd, 2014 (1 Year)

Ticker	Company name	Initial Stock price (usd)	Dividend yield (%)	Shares Bought	Closing stock price (usd)	Annualized dividends	total Dividend Paid	Selling the stocks
T UN EQUITY	AT&T Inc.	35.51	4.96	282	31.95	1.58	445.56	9009.9
VZ UN EQUITY	Verizon communications Inc.	44.56	4.56	224	46.41	2.12	474.88	10395.84
INTC UW EQUITY	Intel Corp	21.36	4.07	468	23.95	0.97	453.96	11208.6
MRK UN EQUITY	Merck& Co Inc.	41.83	4.04	239	52.08	2.1	501.9	12447.12
DD UN EQUITY	EL du Pont Nemours &co	47.98	3.54	208	59.99	2.12	440.96	12477.92
JNJ UN EQUITY	Johnson& Johnson	74.18	3.24	135	86.78	2.8	378	10847.5
PFE UN EQUITY	Pfizer Inc.	27.63	3.18	362	30.60	0.97	351.14	11077.2
MSFT UW EQUITY	Microsoft Corp	27.93	3.08	358	36.48	1.12	400.96	13059.84
HPQ UN EQUITY	Hewlett-Packard Co	16.46	3.05	608	14.02	0.43	261.44	8524.16
CXV UN EQUITY	Chevron Corp	116.50	3.01	86	111.14	3.35	288.1	9558.04
TOTALS							3996.9	108606.1

Assuming Lusia Narsomi had $100,000 to invest on Feb 1^st, 2013, the amount would be distributed at 10% to all the 10 stocks. This means that the original value of the portfolio is $100,000 and each stock would get $10,000. At the end of the one year, the investment value has increased from $100,000 to $108606.1 before dividends and $112603.0 including the dividends. ($112603.0-$100,000)= $12603 and this makes an investment growth of (12,603/100,000*100) = 12.603%.

Table 2. Small Dogs of the Dow

Ticker	Company name	Initial Stock price (usd)	Dividend yield (%)	Shares Bought	Closing stock price (usd)	Annualized dividends	total Dividend Paid	Selling the stocks
T UN EQUITY	AT&T Inc	35.51	4.96	563	31.95	1.58	889.54	17987.85
INTC UW EQUITY	Intel Corp	21.36	4.07	936	46.41	1.9	1778.4	43439.76
PFE UN EQUITY	Pfizer Inc.	27.63	3.18	724	30.60	0.97	702.28	22154.4
MSFT UW EQUITY	Microsoft Corp	27.93	3.08	716	36.48	1.12	801.92	26119.68
HPQ UN EQUITY	Hewlett-Packard Co	16.46	3.05	1215	14.02	0.43	522.45	17034.3
TOTAL							4694.59	126,736.0

Assuming Lusia Narsomi had $100,000 to invest on Feb 1^st, 2013, the amount would be distributed at a rate of 20% to the five stocks. Healthcare 20%, information technology 20% and telecommunication services 20%, this means each would get $20,000. At the end of the financial year, the portfolio value will have increased from $100,000 to $126,736.0 before dividend and to $131430.6 when dividends are paid. This is a ($126,736.0-$100,000) = $31,430.6 increase in value and ($31,430.6/-$100,000 * 100) =31.43% growth rate.

A look at the two results shows that the Small Dogs of the Dow outperformed the Dogs of the Dow by almost three folds. The major similarity between these two variants is that they have both gave the investor positive returns at a minimum risk exposure. However, the major difference is that the Small Dogs of the Dow at 31.43% growth rate outperformed the market considering the S&P 500 return for the year was 29.60%. The Dogs of the Dow, on the other hand, underperformed relative to the market. The results of the two portfolios is a pointer to the possibility that dividend yield alone is not enough tool for use when making investment decisions. This is because when an additional factor was added in selecting the stocks for the Small Dogs of the Dow, it outperformed the Dogs of the Dow by almost three folds. The results also indicate that 10 might not be the most ideal number of stocks to invest in when using the method. While, a smaller number of stock increase an investor’s risk exposure, it still remains at the minimal considering that the Dow 30 are blue chips.

QUESTION 3

Table 3, Dogs of the Dow in a Short Time period (6 month holding) from Feb 1^st 2013 to August 1^st 2013

Ticker	Company name	Initial Stock price (usd)	Dividend yield (%)	Shares Bought	Closing stock price (usd)	Annualized dividends	total Dividend Paid	Selling the stocks
T UN EQUITY	AT&T Inc	35.51	4.96	282	35.72	0.89	250.98	10073.04
VZ UN EQUITY	Verizon communications Inc,	44.56	4.56	224	50.01	1.14	255.36	11202.24
INTC UW EQUITY	Intel Corp	21.36	4.07	468	23.20	0.47	219.96	10857.6
MRK UN EQUITY	Merck& Co Inc	41.83	4.04	239	48.58	0.98	234.22	11610.62
DD UN EQUITY	EL du Pont Nemours &co	47.98	3.54	208	58.458	1.03	214.24	12157.6
JNJ UN EQUITY	Johnson& Johnson	74.18	3.24	135	93.77	1.52	205.2	1265.95
PFE UN EQUITY	Pfizer Inc.	27.63	3.18	362	29.11	0.46	166.52	10537.82
MSFT UW EQUITY	Microsoft Corp	27.93	3.08	358	31.67	0.49	175.42	11337.86
HPQ UN EQUITY	Hewlett-Packard Co	16.46	3.05	608	13.12	0.2	121.6	7976.96
CXV UN EQUITY	Chevron Corp	116.50	3.01	86	126.44	1.9	163.4	10873.84
TOTALS							1751.54	97893.53

When the recommended investment time of the Dogs of the Dow approach is reduced then the strategy stops working as seen here. While the same stocks gave a return of 12.603% when the portfolio was held for a year, it results in losses when the time is cut to six months. This goes to show that time is an important parameter for the strategy to work. As such six months or any other time period less than a year is not appropriate.

Table 4, Dogs of the Dow in a Different Season from Feb 1^st, 2012 to Feb 1^st, 2013

Ticker	Company name	Initial Stock price (usd)	Dividend yield (%)	Shares Bought	Closing stock price (usd)	Annualized dividends	total Dividend Paid	Selling the stocks
T UN EQUITY	AT&T Inc.	29.60	5.98	338	35.51	2.12	716.56	12002.38
VZ UN EQUITY	Verizon communications Inc.	37.80	3.72	265	44.56	1.66	439.9	11808.4
INTC UW EQUITY	Intel Corp	26.55	3.33	377	21.36	0.71	267.67	8052.72
MRK UN EQUITY	Merck& Co Inc.	38.63	4.35	259	41.83	1.82	471.38	10833.97
DD UN EQUITY	EL du Pont Nemours &co	51.56	3.34	194	47.98	1.60	310.4	9308.12
JNJ UN EQUITY	Johnson& Johnson	65.69	3.71	152	74.18	2.75	418	11275.36
PFE UN EQUITY	Pfizer Inc.	21.31	4.22	469	27.63	1.17	548.73	12958.47
MSFT UW EQUITY	Microsoft Corp	29.89	2.88	335	27.93	0.8	268	9356.55
HPQ UN EQUITY	Hewlett-Packard Co	14.38	3.67	695	8.230	0.3	208.5	5719.85
CXV UN EQUITY	Chevron Corp	102.79	3.41	97	116.50	4.0	388	11300.5
TOTALS							4037.14	102616.32

Despite the changes, the Dogs of the Dow stock picking strategy has consistency since it is able to give the investor returns. The value of the investment including reinvested dividend is $106653.46. This means that it had a $6653.46 increase in value, which is approximately a 6.65% increase in value. This shows that the Dogs of the Dow is not season sensitive but is consistent. The only thing that changes is the degree of returns. This is because the levels of returns vary over the years. In some years the Dogs of the Dow performs very well and beats the market performance while in others it has an average return rate.

QUESTION 4

Table 5, High Net Payout Yield Stocks from Feb 1st, 2013 and Feb 3rd, 2014 (1 Year)

Ticker	Company name	Initial Stock price (usd)	Dividend yield (%)	Shares Bought	Closing stock price (usd)	Annualized dividends	total Dividend Paid	Selling the stocks
VZ UN EQUITY	Verizon communications Inc.	44.56	4.56	224	46.41	2.12	474.88	10395.84
PG UN EQUITY	Proctor and Gamble	75.92	2.91	132	75.70	2.2	290.4	9992.4
INTC UW EQUITY	Intel Corp	21.36	4.07	468	23.95	0.97	453.96	11208.6
MRK UN EQUITY	Merck& Co Inc.	41.83	4.04	239	52.08	2.1	501.9	12447.12
MCD UN EQUITY	McDonald’s corp	95.95	2.99	104	93.02	2.78	289.12	9674.08
KO UN EQUITY	Coca-Cola co	37.54	2.66	266	37.20	0.99	263.34	9898.2
PFE UN EQUITY	Pfizer Inc.	27.63	3.18	362	30.60	0.97	351.14	11077.2
MSFT UW EQUITY	Microsoft Corp	27.93	3.08	358	36.48	1.12	400.96	13059.84
CSCO UW EQUITY	Cisco Systems Inc.	20.84	1.73	480	21.55	0.37	177.6	10344
IBM UN EQUITY	Int’nl business machine	205.18	1.61	49	172.90	2.78	136.22	8472.1
TOTALS							3339.60	106569.3

The resulting portfolio is a mixture of winners and losers, however, economic and financial knowledge create the expectation that this portfolio that is based on High Net Payout Yield stocks should outperform the Dogs of Dow. The Dogs of Dow portfolio has an $112603.0 valuation compared to $109,908.98 by the High Net Payout Yield strategy. The most probable explanation for the existence of this situation is that this is a period just after the financial crisis and most companies in the country are yet to re-reach 100% level of operations. The High Net Payout Yield strategy is supposed to outperform the dogs of the Dow approach because it uses extra parameters other than dividend.

QUESTION 5

It is true that the Dogs of the Dow investment strategy is not limited to the settings of American blue chip companies and their shares. This strategy can be used successfully around the world in any developed financial and securities markets. This includes the case of the Dogs of the Stoxx which offers a way to invest in undervalued Eurozone blue chip companies. While one may be tempted to make a pick between the Dogs of the Dow and the Dogs of the Stoxx, none of the two is superior to the other. As noted in this paper, the success of the strategy is directly related to the ability of an investor following the guidelines of the strategy to the latter. As such, none of the two has more back than the other. The success of the strategy comes down following the defined process.