THE DOGS OF THE DOW

Published: 2021-07-06 23:12:19
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QUESTION 1The Dogs of the Dow is a stock picking investment strategy that is based on the dividend yields of the 30 stocks that make up the Dow Jones Industrial Average (DOW). Based on this strategy, after the stock market closes on the last day of the year, an investor is supposed to select the ten stocks with the highest dividend yield from the list of the 30 stocks that make up the Dow Jones Industrial Average. Subsequently, he/she invests an equal dollar allocation in each of ten high dividend yield stocks. The Dogs of the Dow strategy aims at outperforming the market’s performance by buying 10 undervalued blue-chip stocks. These stocks are undervalued given that they offer high dividend yields. The high dividend yields is an indication that they are in a position to generate returns (dividend) for the investor. This raises the other rational which is that there is a possibility that they are undervalued since their high dividends returns is not reflected in their relatively low share price.The strategy is made more effective by the fact that the 30 stocks that make up the Dow Jones Industrial Average represent the country’s largest, most liquid and well-reputed companies that have had long-term sustainable growth. This means that they represent the main industries and general economic condition of the country. As a result, any sector concentrated risks raised by any individual industry is be eliminated through the diversification. Therefore, investors are in a position to reach the objective of attaining higher returns while having considerably low-risk exposure.On the other hand, Small Dog is an investment strategy for investors aiming a beating the performance of both the market and the Dogs of the Dow strategy. While it carries a high rate of expected returns, it also has a higher rate of risk compared to the Dogs of the Dow strategy. Under the small dogs approach, an investor selects five stocks with the lowest price from the 10 Dogs of the Dow. These five are the small dogs and upon selection, the same investment procedure used in the Dogs of the Dow strategy is applied here.Dividend yield is the financial ratio that shows how much a listed company pays out to shareholders as dividend each year relative to the market value per share. It is calculated by taking a share’s indicated dividend (last quarterly dividend) multiply by four then dividing it by the existing share price. As such if a share’s price increases at a rate higher than its dividend, the yield falls. To investors, this is an indication that the stock price is ready for a drop.At the same time, in case the dividend yield rises sustainably the stock price may be poised for an increase. This is how a high dividend yield can be an indicator of the undervaluation of a stock. This is because the high dividend yield attracts value investors. These investors start purchasing the stock of the company; the increase in demand for the share causes the denominator (price) in the dividend yield’s formula to increases. This pushes the ratio downwards. The decline in dividend yield causes the value investors to start selling their stock holdings since it is no longer an attractive investment based on a dividend-yield approach. The drop in demand as investors exit their positions causes a drop in price and once again the dividend yield starts increasing. This makes it an attractive option to value investors. Once again the price of the share increases.It is as a result of these cycles of price increase that a high dividend yield might indicate the undervaluation of a stock. However, it should be noted that the high dividend yield should be sustainable and historically significant for it to indicate an undervaluation of the stock concerned.QUESTION 1The tables below represent the Dogs of the Dow and the Small Dogs for the year 2013.Table 1. Dogs of the Dow from Feb 1st, 2013 and Feb 3rd, 2014 (1 Year)TickerCompanynameInitial Stock price (usd)Dividend yield (%)Shares BoughtClosing stock price (usd)Annualized dividendstotalDividendPaidSelling the stocksT UN EQUITYAT&T Inc.35.514.9628231.951.58445.569009.9VZ UN EQUITYVerizon communications Inc.44.564.5622446.412.12474.8810395.84INTC UW EQUITYIntel Corp21.364.0746823.950.97453.9611208.6MRK UN EQUITYMerck& Co Inc.41.834.0423952.082.1501.912447.12DD UN EQUITYEL du Pont Nemours &co47.983.5420859.992.12440.9612477.92JNJ UN EQUITYJohnson&Johnson74.183.2413586.782.837810847.5PFE UN EQUITYPfizer Inc.27.633.1836230.600.97351.1411077.2MSFT UW EQUITYMicrosoft Corp27.933.0835836.481.12400.9613059.84HPQ UN EQUITYHewlett-Packard Co16.463.0560814.020.43261.448524.16CXV UN EQUITYChevron Corp116.503.0186111.143.35288.19558.04TOTALS 3996.9108606.1Assuming Lusia Narsomi had $100,000 to invest on Feb 1st, 2013, the amount would be distributed at 10% to all the 10 stocks. This means that the original value of the portfolio is $100,000 and each stock would get $10,000. At the end of the one year, the investment value has increased from $100,000 to $108606.1 before dividends and $112603.0 including the dividends. ($112603.0-$100,000)= $12603 and this makes an investment growth of (12,603/100,000*100) = 12.603%.Table 2. Small Dogs of the Dow TickerCompanynameInitial Stock price (usd)Dividend yield (%)Shares BoughtClosing stock price (usd)Annualized dividendstotalDividendPaidSelling the stocksT UN EQUITYAT&T Inc35.514.9656331.951.58889.5417987.85INTC UW EQUITYIntel Corp21.364.0793646.411.91778.443439.76PFE UN EQUITYPfizer Inc.27.633.1872430.600.97702.2822154.4MSFT UW EQUITYMicrosoft Corp27.933.0871636.481.12801.9226119.68HPQ UN EQUITYHewlett-Packard Co16.463.05121514.020.43522.4517034.3TOTAL4694.59126,736.0Assuming Lusia Narsomi had $100,000 to invest on Feb 1st, 2013, the amount would be distributed at a rate of 20% to the five stocks. Healthcare 20%, information technology 20% and telecommunication services 20%, this means each would get $20,000. At the end of the financial year, the portfolio value will have increased from $100,000 to $126,736.0 before dividend and to $131430.6 when dividends are paid. This is a ($126,736.0-$100,000) = $31,430.6 increase in value and ($31,430.6/-$100,000 * 100) =31.43% growth rate.A look at the two results shows that the Small Dogs of the Dow outperformed the Dogs of the Dow by almost three folds. The major similarity between these two variants is that they have both gave the investor positive returns at a minimum risk exposure. However, the major difference is that the Small Dogs of the Dow at 31.43% growth rate outperformed the market considering the S&P 500 return for the year was 29.60%. The Dogs of the Dow, on the other hand, underperformed relative to the market. The results of the two portfolios is a pointer to the possibility that dividend yield alone is not enough tool for use when making investment decisions. This is because when an additional factor was added in selecting the stocks for the Small Dogs of the Dow, it outperformed the Dogs of the Dow by almost three folds. The results also indicate that 10 might not be the most ideal number of stocks to invest in when using the method. While, a smaller number of stock increase an investor’s risk exposure, it still remains at the minimal considering that the Dow 30 are blue chips.QUESTION 3Table 3, Dogs of the Dow in a Short Time period (6 month holding) from Feb 1st 2013 to August 1st 2013 TickerCompanynameInitial Stock price (usd)Dividend yield (%)Shares BoughtClosing stock price (usd)Annualized dividendstotalDividendPaidSelling the stocksT UN EQUITYAT&T Inc35.514.9628235.720.89250.9810073.04VZ UN EQUITYVerizon communications Inc,44.564.5622450.011.14255.3611202.24INTC UW EQUITYIntel Corp21.364.0746823.200.47219.9610857.6MRK UN EQUITYMerck& Co Inc41.834.0423948.580.98234.2211610.62DD UN EQUITYEL du Pont Nemours &co47.983.5420858.4581.03214.2412157.6JNJ UN EQUITYJohnson&Johnson74.183.2413593.771.52205.21265.95PFE UN EQUITYPfizer Inc.27.633.1836229.110.46166.5210537.82MSFT UW EQUITYMicrosoft Corp27.933.0835831.670.49175.4211337.86HPQ UN EQUITYHewlett-Packard Co16.463.0560813.120.2121.67976.96CXV UN EQUITYChevron Corp116.503.0186126.441.9163.410873.84TOTALS 1751.5497893.53When the recommended investment time of the Dogs of the Dow approach is reduced then the strategy stops working as seen here. While the same stocks gave a return of 12.603% when the portfolio was held for a year, it results in losses when the time is cut to six months. This goes to show that time is an important parameter for the strategy to work. As such six months or any other time period less than a year is not appropriate.Table 4, Dogs of the Dow in a Different Season from Feb 1st, 2012 to Feb 1st, 2013 TickerCompanynameInitial Stock price (usd)Dividend yield (%)Shares BoughtClosing stock price (usd)Annualized dividendstotalDividendPaidSelling the stocksT UN EQUITYAT&T Inc.29.605.9833835.512.12716.5612002.38VZ UN EQUITYVerizon communications Inc.37.803.7226544.561.66439.911808.4INTC UW EQUITYIntel Corp26.553.3337721.360.71267.678052.72MRK UN EQUITYMerck& Co Inc.38.634.3525941.831.82471.3810833.97DD UN EQUITYEL du Pont Nemours &co51.563.3419447.981.60310.49308.12JNJ UN EQUITYJohnson&Johnson65.693.7115274.182.7541811275.36PFE UN EQUITYPfizer Inc.21.314.2246927.631.17548.7312958.47MSFT UW EQUITYMicrosoft Corp29.892.8833527.930.82689356.55HPQ UN EQUITYHewlett-Packard Co14.383.676958.2300.3208.55719.85CXV UN EQUITYChevron Corp102.793.4197116.504.038811300.5TOTALS 4037.14102616.32Despite the changes, the Dogs of the Dow stock picking strategy has consistency since it is able to give the investor returns. The value of the investment including reinvested dividend is $106653.46. This means that it had a $6653.46 increase in value, which is approximately a 6.65% increase in value. This shows that the Dogs of the Dow is not season sensitive but is consistent. The only thing that changes is the degree of returns. This is because the levels of returns vary over the years. In some years the Dogs of the Dow performs very well and beats the market performance while in others it has an average return rate.QUESTION 4Table 5, High Net Payout Yield Stocks from Feb 1st, 2013 and Feb 3rd, 2014 (1 Year)TickerCompanynameInitial Stock price (usd)Dividend yield (%)Shares BoughtClosing stock price (usd)Annualized dividendstotalDividendPaidSelling the stocksVZ UN EQUITYVerizon communications Inc.44.564.5622446.412.12474.8810395.84PG UN EQUITYProctor and Gamble75.922.9113275.702.2290.49992.4INTC UW EQUITYIntel Corp21.364.0746823.950.97453.9611208.6MRK UN EQUITYMerck& Co Inc.41.834.0423952.082.1501.912447.12MCD UN EQUITYMcDonald’s corp95.952.9910493.022.78289.129674.08KO UN EQUITYCoca-Cola co37.542.6626637.200.99263.349898.2PFE UN EQUITYPfizer Inc.27.633.1836230.600.97351.1411077.2MSFT UW EQUITYMicrosoft Corp27.933.0835836.481.12400.9613059.84CSCO UW EQUITYCisco Systems Inc.20.841.7348021.550.37177.610344IBM UN EQUITYInt’nl business machine205.181.6149172.902.78136.228472.1TOTALS 3339.60106569.3The resulting portfolio is a mixture of winners and losers, however, economic and financial knowledge create the expectation that this portfolio that is based on High Net Payout Yield stocks should outperform the Dogs of Dow. The Dogs of Dow portfolio has an $112603.0 valuation compared to $109,908.98 by the High Net Payout Yield strategy. The most probable explanation for the existence of this situation is that this is a period just after the financial crisis and most companies in the country are yet to re-reach 100% level of operations. The High Net Payout Yield strategy is supposed to outperform the dogs of the Dow approach because it uses extra parameters other than dividend.QUESTION 5It is true that the Dogs of the Dow investment strategy is not limited to the settings of American blue chip companies and their shares. This strategy can be used successfully around the world in any developed financial and securities markets. This includes the case of the Dogs of the Stoxx which offers a way to invest in undervalued Eurozone blue chip companies. While one may be tempted to make a pick between the Dogs of the Dow and the Dogs of the Stoxx, none of the two is superior to the other. As noted in this paper, the success of the strategy is directly related to the ability of an investor following the guidelines of the strategy to the latter. As such none of the two has more back than the other. The success of the strategy comes down following the defined process.

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