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What's Up With the Dow Dogs?

Lagging the market thus far, the strategy looks set to keep its winning streak alive.

Investors who bought into the well-known "Dogs of the Dow" strategy at the beginning of the year are up 2.8% year to date, according to

dogsofthedow.com. And while that trails the overall

Dow

performance of 6.5%, Dog-fund manager Neil Hennessy is telling the skeptics to heel.

"This strategy is not a get-rich-quick scheme," says Hennessy, who oversees the $95 million

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Hennessy Total Return fund. "It's designed to provide a consistent return with low volatility. It's a very disciplined approach to investing."

Hennessy's fund puts 75% of its assets in the dogs and the other 25% in one-year Treasury bills. According to fund-tracker Morningstar, the fund is up 3.7% year to date.

For those unfamiliar with the concept, the Dogs of the Dow is an investment strategy that advocates buying the 10 Dow Jones Industrial Average stocks with the highest dividend yields. Adherents to the dogs' philosophy believe these beaten-down stocks -- remember, yield moves inversely to price -- are undervalued and due to rally.

Typically, dog investors readjust their portfolios at the beginning of each calendar year. The 2007 list:

The average yield for the 10 mega-cap stocks is 3.57%.

Want more? Check out TheStreet.com TV video.Gregg Greenberg takes a closer look at the Dogs.

The strategy was first popularized by Michael O'Higgins in his book

Beating the Dow

, published in 1991. O'Higgins showed that over the 17-year period from 1973 to 1989, his dogs strategy averaged a return of 17.9% annually, compared with 11.1% for the 30 stocks in the Dow.

More recently, during the tech bubble of the late 1990s, the value-based dogs remained positive, although they lagged behind the returns of the

S&P 500

, which favored growth stocks. When growth stocks went decidedly out of favor during the ensuing bear market, the dogs behaved magnificently, outperforming the S&P by 15.6 percentage points in 2000, 7 points in 2001 and 13.2 points in 2002.

The picks of this year's litter include telecoms Verizon and AT&T, which are up 14.4% and 12.2% year to date, respectively, as well as drugmaker Merck, which is up 15%.

Barring a major turnaround, the financials would have to be considered the runts so far this year. J.P. Morgan is down 7% and Citigroup is down 14%, raising their respective yields to 3% and 4.5%.

Despite the banks' poor performance, the proudly bullish Hennessy says they will muddle through once the subprime problems are shaken out of the system. ("Wall Street came up with these fixed income products and now they are paying for it!") Once that occurs, he projects the economy, the Dow and his Dogs will run.

"Nothing has changed the bullish case," says Hennessy, who predicts the 30-stock Dow will finish the year above 14,000. "Inflation remains low. Unemployment is still low. Companies have $2 trillion on their balance sheets. Where would you put money? Real estate? Low-yielding bonds? No way. All that's left is the equity market."

Before joining TheStreet.com, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.

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