This Simple Dividend Strategy Is Crushing the Dow

This Simple Dividend Strategy Is Crushing the Dow

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Over the past week, investors have gotten a lot more nervous about the future prospects of the stock market, as the Dow Jones Industrials dropped more than 2%. But it's important to remember that even after this week's decline, the Dow is still up 15% on the year -- a more than respectable full-year return in many years.

But if the 30 stocks in the Dow are too many for you to follow, there's a simple strategy that focuses on dividend yields. That strategy is known as the Dogs of the Dow, and at least this year, it's been doing a lot better than the Dow -- six full percentage points better as of Friday.

How the Dogs work
The Dogs of the Dow strategy couldn't be easier to follow. All you have to do is take the 10 top-yielding stocks at the beginning of the year and invest equal amounts in each of them. Then you just hold onto your shares all year, and then repeat the process with a potentially new group of 10 stocks next year.

The theory behind the Dogs of the Dow is that the highest-yielding stocks in the average tend to be beaten-down value stocks that in many cases are poised for rebounds. By contrast, lower-yielding Dow stocks that don't get included among the Dogs are sometimes overvalued and primed for corrections.

Why the strategy has worked this year
That theory has played out perfectly so far this year. DuPont has been one of the best-performing Dogs this year, having followed up a small loss of about 2% last year with a nearly 30% gain this year. The chemical giant has increasingly emphasized the more lucrative agricultural side of its business, with a recent announcement that it would seek to sell off its Performance Chemicals business to focus more on fertilizer, pesticides, and seeds.

The biggest success for the Dogs has come from Hewlett-Packard , which has soared 85% after dropping 45% in 2012. The beauty of the bottom-fishing Dogs strategy is that it avoided HP's losses from the early halting stages of its recovery efforts while reaping the stock's gains once those turnaround strategies starting taking shape and moving forward more aggressively.

At the same time, avoiding low-yielding stocks has helped the Dogs avoid the worst performers in the Dow. Both Caterpillar and Alcoa fall among the bottom 10 yielding Dow stocks, and both have suffered from the slowdown in emerging-market growth that has led to a big disparity between the positive perceptions of the U.S. economy and relative sluggishness in much of the rest of the world.

Will the Dogs win out?
With more than four months left to go in the year, victory from the Dogs is far from assured. But with a nice head-start, the Dogs show how even simple strategies can sometimes pay off with outsized returns. That won't happen every year, but under the right conditions, the Dogs of the Dow can help you focus on bargain opportunities with lucrative income potential as well.

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