Intel, Microsoft Lift 'Dogs of the Dow' Toward a Winning 2014

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Sam Yeh/AFP/Getty ImagesRenee J. James is president of Intel.
With interest rates still near record lows, and classic safe investments paying meager returns, growing numbers of conservative (and savvy) investors are turning to dividend stocks to generate the income they need from their investments. Dividend stocks have also produced stronger total returns than the overall market, which has led more investors to use strategies aimed at emphasizing those dividend stocks.

One such strategy is known as the Dogs of the Dow. At the beginning of each year, you buy the 10 stocks out of the 30 members of the Dow Jones industrials (^DJI) whose dividend is the largest fraction of their share price. Then, you hold on to those stocks throughout the year, collecting their dividends. When the year ends, then you take a fresh look at the top dividend yields in the Dow and make any necessary adjustments.

Because dividends are paid out as a set amount per share, they don't fluctuate with stock price. This means the dividend ratio does. Lower stock prices equal higher dividend ratios -- your cue to buy.

The strategy is doing fairly well this year, and one big reason is the outperformance of Dow tech components Microsoft (MSFT) and Intel (INTC) so far in 2014.

The Dogs in This Race

Over the past dozen years, the Dogs have beaten the return of the overall Dow Jones industrials six times, and the Dow has beaten the Dogs the other six. Most recently, the Dogs have had a good run, beating the Dow in three of the past four years.

So far in 2014, the Dogs and the Dow are neck and neck, with the Dogs producing gains of nearly 8 percent and beating the Dow's current pace by 2 percentage points. A large part of that success has come not only from having tech's strongest players among the Dogs but also in avoiding the worst Dow stock in tech.

A Tale of Two Tech Markets

The successes of Microsoft and Intel have come to a large extent from a revival of their core business areas. In particular, Intel has struggled in recent years as the mobile revolution threatened to leave the dominant PC-chip company behind, with competitors taking control of the high-performance mobile-chip market. But as Microsoft's support for its Windows XP operating system ended earlier this year, Intel saw an upsurge in its sales thanks to a rise in sales of traditional PCs. Even as some concerns have arisen about the sustainability of that trend, Intel has also made strides toward improving its position among mobile-chip makers, and Intel stock has ridden that optimism higher by about 29 percent so far in 2014.

Microsoft's operating system and office software businesses also rely on brisk PC sales for a big piece of revenue. But another contributing factor in Microsoft's success in 2014 has been the ascent of new CEO Satya Nadella, who has broken the company out of what many saw as a rut under former CEO Steve Ballmer and started making more aggressive moves toward innovation and competition. Initiatives emphasizing cloud computing and recurring revenue have the potential to become game-changers in the way that the tech giant makes money in the future. Microsoft's willingness to become less platform-centric and instead focus on delivering valuable services regardless of what type of hardware customers are using has driven more enthusiasm about the stock, which is a big part of why Microsoft has gained 30 percent so far this year.

%VIRTUAL-pullquote-IBM is the worst performer in the Dow this year, falling more than 13 percent.%As strong an influence as Intel and Microsoft have had, the fact that the Dogs didn't have International Business Machines (IBM) on the list has been a big factor in their current lead. IBM is the worst performer in the Dow this year, falling more than 13 percent as the company has seen declining revenue as a result of its attempts to shift toward higher-margin business lines. Despite extensive share buybacks, IBM looks poised to miss its target for earnings this year, and with all the competition from Microsoft and other big players in the IT services industry, IBM stock has a long way to go to recover from its malaise in 2014.

With roughly six weeks to go before the end of the year, the Dogs of the Dow don't have an insurmountable lead by any stretch. Still, the strength of the Dow's high-dividend tech stocks points to the usefulness of the Dogs of the Dow strategy as a simple but largely effective way to get more dividend income and still see good total return performance.

Motley Fool contributor Dan Caplinger never saw a dividend he didn't like getting. He doesn't own shares of the companies mentioned in this article. You can follow him on Twitter @DanCaplinger or on Google+. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel, International Business Machines and Microsoft. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.
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