The Dogs of the Dow. It has such a nice ring to it doesn’t it? Almost everybody who has been around investing for a while has some understanding of what that phrase means. It’s quite possibly the most famous of all dividend investing strategies having been popularised by Michael O’Higgins in a 1991 book called ‘Beating the Dow’. So the trick goes, by investing in the 10 highest yielding stocks in the Dow Jones index once per year for a whole year you could beat the Dow, and with it probably the majority of most active fund managers. To top it all the Dogs of the Dow backtest worked extremely well; beating the market by almost 4% a year over about 20 years. But investors who do throw money into high dividend yield strategies have often found the reality much harder going… the truth is that high yielding stocks may well be the finance equivalent of surgery enhanced middle aged women. They might look pretty at a stretch, but you may well be disappointed when you take them home.
Putting dogs to work
Firstly its worth understanding why high yield strategies ought to work, and the why rests predominantly on investor over-reaction. Dividend investors prize certainty over everything else. Pension funds are under pressure to pay out a constant stream of income and need their investments to bear expected fruit. So whenever a stock looks to be at risk of suffering from a dividend cut or under business pressure a large group of shareholders start to ask questions… “where will the yield end up?”, “how big will the cut be?”,“will these problems continue?”… as a result many will often sell regardless of price and reinvest in safer more certain waters.
But these worries often drive prices down too low for the risk, providing opportunity for canny contrarians. Even if a dividend cut does occur, you may well end up getting a half-decent yield after all, but more importantly you can end up with a nice capital return to boot as the uncertainty surrounding the stock dissipates. So buying high yielding stocks can give you two bangs for your buck.
Man's best friend?
So there are certainly some good behavioural reasons why a high yield strategy can make sense and at first glance the record seems to back it up. Tweedy…
