Clark Wealth Management Group - ScotiaMcLeod Fredericton

In 1991 an American author named Michael O’Higgins published a book called “Beating the Dow”. In it he suggested a strategy known today as “Dogs of the Dow”. It is called the “Dogs” of the Dow because it involves buying common shares that have the highest dividend yield. A share’s dividend yield is often highest when the share price is the lowest. Buying shares of companies when the prices have gone down is often sensible but it is not what most investors do. In investing, doing the opposite of what the crowd is doing can be very rewarding. Although in the past 15 years the magnitude of the outperformance has declined, over the long term choosing the so-called “Dogs of the Dow” has outperformed the Dow Jones Industrial Average (DJIA).

Here’s how the strategy works. At the beginning of each year buy equal amounts of the 10 highest dividend yielding common shares from the list of the 30 stocks that make up the DJIA. Rebalance annually to the new list of the 10 highest yielding stocks.

While we’re not the first Canadians to look at how the strategy might work at home, ScotiaMcLeod’s Portfolio Advisory Group recently tested the strategy using the shares that make up the Canadian blue chip S&P/TSX 60 index. They went back to the end of 2001 and ran the strategy. The back-testing showed that the strategy would have returned 245% versus the S&P/TSX total return over the same period of 101%. Although these numbers exclude investment costs, even if we add 2.5% per year in costs the outperformance over the period is about 121%.

The “Dogs of the TSX” strategy also outperformed consistently, beating the broader index 7 out of the 9 years tested. The strategy worked especially well in down markets during the period reviewed.

Here are a few examples: In 2002 the index went down 14% while the “dogs” went up 4.7%; in 2008 when the S&P/TSX index went down 31.2% the “dogs” went down only 10%. In up markets it also did well. In 2009 when the index went up 31.9% the “dogs” went up 43.6%; in 2005 while the index did better going up by 26.3% the “dogs” did a very respectable 25.6%.

Keep in mind that the focus of the holdings in this strategy (only 10 large cap Canadian companies) increases the need to ensure the remainder of your portfolio is well diversified. It would be particularly important to diversify away from the Canadian large cap equity market to avoid overinvesting in one type of investment.

If you were to put the strategy in place as at November 1, 2010, the list of candidates for inclusion in this “Dogs of the TSX” portfolio would be: Yellow Pages, Canadian Oil Sands, Enerplus Resources, TransAlta Corp. ARC Energy Trusts, BCE Inc, Sun Life Financial, Husky Energy, Bank of Montreal and PennWest Energy. The combined dividend yield of the portfolio would be 6.41% at present.

While this is a unique and potentially profitable way to approach the Canadian equity market, it is not a strategy for everyone. The risks of owning common equity, even large cap dividend paying equity are not at all similar to owning GICs or high quality bonds. Be sure to take the time to fully understand the role this strategy could play in your portfolio, if any. Your own professional advisor, particularly one who is appropriately licensed and skilled at working with individual securities, would be best equipped to help you with that analysis.

Keir Clark, is a senior wealth advisor, with Clark Wealth Management Group and branch manager at ScotiaMcLeod in Fredericton, NB. He can be reached online at www.keirclark.ca or by telephone at 506-450-6465.

Information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, expressed or implied, is made as to the accuracy or completeness.