Dow's "Dogs" Could Be Key to Success in This Market

By George Leong

The Dow Jones Industrial Average rallied for 10 straight days and, in the process, established several record highs. And while the Wall Street bulls are glorifying the upward move, I continue to believe a correction is on the way—I just can’t tell you when or by how much. The thing I would warn you against is chasing dividends on Dow stocks. The average dividend yield on the 30 Dow stocks currently sits around 2.82%.

The top-five dividend yields belong to AT&T Inc. (NYSE/T), Intel Corporation (NASDAQ/INTC), Verizon Communications Inc. (NYSE/VZ), Merck & Co., Inc (NYSE/MRK), and Microsoft Corporation (NASDAQ/MSFT). The problem with chasing the dividends on these stocks is that I feel there is limited upside in the share price appreciation potential at this point.

A contrarian trade you can play is employing the “Dogs of the Dow” investment strategy, which is simple and has beaten the Dow on average since 1972. The five companies included in this group are the lowest-priced stocks.

The theory is that these Dow companies are facing some issues, but with a turnaround, they can generate some above-average returns and, as such, are viewed as contrarian stocks.

Let’s take a look at the strategy.

At the close of March 15, the five dogs of the Dow were:

1. Alcoa Inc. (NYSE/AA; $8.58)

2. Bank of America Corporation (NYSE/BAC; $12.38)

3. Intel ($21.20)

4. Cisco Systems, Inc. (NASDAQ/CSCO; $21.68)

5. Hewlett-Packard Company (NYSE/HPQ; $22.42)

Now take a look at the results, assuming you bought these five dog stocks based on the close on December 31, 2012 with the advance to March 18.

The table shows four of the five stocks higher, with only Alcoa slightly in the red. The biggest advance was Hewlett-Packard (HP) at nearly 60%, as the company turns around. I have talked about HP in these pages before and have suggested it would only do well if the company can turn its operations around and deliver results to shareholders.

The average price appreciation of the five dog stocks was around 16.5% as of March 18, which was above the comparative 10.7% return of the 30 Dow stocks.

My analysis is that these five dog stocks have better upside potential than the five highest-yielding stocks (note, however, that Intel belongs to both groups); for those of you who want to take some risk, playing the dogs of the Dow could pay off.

This Article Dow’s “Dogs” Could Be Key to Success in This Market was Originally published at InvestmentContrarians