by Andrew Horowitz

You've probably heard of the "Dogs of the Dow" strategy, but if not, let's take a moment to review what it is, how these selected stocks performed in 2011, and what names might be good candidates for 2012.

First of all, the Dogs of the Dow strategy is a simple quantitative analysis scan of the top ten stocks in the Dow Jones index of 30 stocks that have the highest dividend yield at the beginning of a new year. Investors in the strategy simply buy an equal-dollar amount in each of
these 10 stocks.  Generally, investors sell all of these stocks at the end of the year and then repeat the same strategy, keeping in mind that some stocks may need to stay in the portfolio as they will show up again in the next year's scan.

We find the dividend yield of any stock by dividing the current company dividend with the current price of the stock.  For example, a stock that offers an annual dividend of $1.00 per share and the share price currently trades at $50.00 per share has a dividend yield of 2.0%.

So, in essence, the Dogs of the Dow strategy starts with a universe of 30 large-cap stocks and then selects the top ten stocks with the highest dividend yield, which is usually around 4% to 5%.  That's high when you consider most dividend yields are in the 2% to 3% range.

We don't want to run an entire portfolio this way, but the Dogs of the Dow strategy is one of many popular methods for picking stocks using a consistent, very simple rule-based method.

As a reference, we want to start our search with scanning methods to narrow down a broad universe of stocks and then study ratios using fundamental analysis to find strong stocks, and finally use charts as part of simple technical analysis to assess trend, support and resistance, and good spots to add the stock to the portfolio.
 
The Dogs of the Dow strategy begins and ends with scanning, or a simple form of quantitative analysis.

Anyway, what were the top 10 stocks in 2011 and how did these perform collectively if you bought an equal dollar amount of each of these stocks and then sold them all at the end of 2011?

The top 10 stocks for 2011 were the following, in decending order of dividend yield:

AT&T
Verizon
Pfizer
Merck
Kraft
Johnson & Johnson
Intel
DuPont
McDonald's
Chevron

The top yielding Dow Stock at the beginning of 2011 was AT&T (Symbol: T) with a dividend yield of 5.85%.  Wow!  That's hard to resist adding a stock that almost guarantees you a 6% return thanks to dividends, isn't it?  In general, we want to have other reasons to add a stock to our portfolio, other than it has a high dividend yield!  In 2011, AT&T rose 2% - not very impressive by itself, but the high dividend yield certainly helps.

If you used the pure Dogs of the Dow strategy exclusively in 2011, your portfolio would have increased by about 13%, which was the average performance of the Dogs of the Dow stocks, not including the dividends. You'd add about 3.5% in dividends to give you about a 16% total portfolio performance for 2011.  That's an enviable return when compared against the Dow Jones itself which rose about 6% for 2011.

You can see exactly how the Dogs of the Dow strategy has performed each year by visiting the website www.dogsofthedow.com, where you can learn more details about this type of scanning strategy.

One thing to keep in mind is that a company generally gets a high dividend yield not by increasing the dividend payments to high levels, but by seeing the share price of their stock decline as the dividend remains the same.

In other words, if a company starts the year with a share price at $50 and provides a dividend of $1.00 per share, then the dividend yield is thus a standard 2.0%.

However, if the company keeps the dividend the same throughout the year yet the price of the stock declines to $40 per share, then the dividend yield increases to 2.5%.  That's still reasonable.

If we take it a step further and see the stock price decline to $30 per share, the dividend yield then rises to 3.3%.  That's getting a bit higher than average.

A share price of $20.00 with a dividend of $1.00 per share results in a 5% dividend yield which is getting close to the top stock in the Dogs of the Dow strategy which usually has a dividend yield greater than 5%.

And finally, a company with a $10.00 share price with a $1.00 per share dividend yield results in a very high dividend yield of 10%.  Generally, companies will decrease their dividend payment per share before the dividend yield rises that high.

I bet you're wondering why they call it the "Dogs of the Dow" strategy. That's because these Dow Stocks with the highest dividend yield are generally the 'beaten down' or sometimes unfavored stocks which have seen a relative decline in their share price, or at least have somewhat underperformed other stocks in the Dow in some way.

So the Dogs of the Dow strategy does perform well most years, historically beating the S&P 500 when we add in the dividends, but always do your homework when studying these type of simple strategies.

With that in mind, what are the top five companies right now as 2012 begins?

It's a little surprising that AT&T takes the top spot for a second year in a row, this time with a dividend yield at 5.9%!

Coming in right under AT&T in terms of dividend yield are the following Dow Jones components:

Verizon Communications, Merck, Pfizer, and General Electric.

Take a moment to research these stocks and see if these would be good additions to your growing portfolio, but remember to do your homework instead of rushing out, running a scan, and adding stocks with which you're unfamiliar to your portfolio!

And of course consider picking up a copy of my latest book The Winning Investor's Guide to Making Money in Any Market is available at Amazon and other fine booksellers and in print and digital versions too!

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