The Dogs of the Dow is an investment strategy popularized in the early 1990s by Michael O'Higgins in his book "Beating The Dow" (1992). The original strategy involves picking the ten highest dividend yielding Dow stocks at the beginning of the year in equal proportions and recalibrating the portfolio each year. The strategy is grounded in the theory that the Dow component stocks are blue chips that don't alter their dividend payouts to reflect market conditions. Due to this stable policy, the dividends are reflective of the true value of the companies. The Dogs offer higher yields because the market has soured on them, so buying in when the yields are high and then waiting for the market to reflect the true value of the shares can pay off.

In his book, O'Higgins showed that the Dog strategy returned 17.9% annually compared with 11.1% for the Dow over a 17-year period from 1973 to 1989. That is a great return, however in 2007 the strategy faltered. But, the strategy can at least point us in the direction of some of the highest yielding blue chips while we sift out the undesirables. (For more on dividends, read our educational articles The Power Of Dividend Growth, and The Importance Of Dividends.)

The Dog House





Company


Share Price


Dividend Yield


Bank of America (NYSE:BAC)


$32.25


7.94%


Citigroup (NYSE:C)


$19.39


6.60%


Pfizer (NYSE:PFE)


$19.84


6.45%


AT&T (NYSE:T)


$30.97


5.17%


Verizon (NYSE:VZ)


$34.59


4.97%


Merck (NYSE:MRK)


$35.95


4.23%


General Electric (NYSE:GE)


$29.64


4.18%


JPMorgan Chase (NYSE:JPM)


$41.07


3.70%


Dupont (NYSE:DD)


$45.31


3.62%


AIG (NYSE:AIG)


$24.87


3.54%


Data as of market close August 8, 2008



As alluded to above, the traditional dog strategy would not be recommended here. Some of these stocks have positive prospects, some have negative, and some have been dogs for a long time. A better strategy is to pick the best stocks of the bunch and consider adding those to a portfolio.

Little Blue Chip
Drug stocks have taken a beating over the past year thanks to prevailing market conditions, competition from generic players, and company specific issues. However, over the long haul, I remain bullish on the business, and one of the companies in the group that I think deserves more than a passing glance is Pfizer.

Pfizer has a number of well-known, well-respected products including: Benadryl, Viagra, Xanax, Lipitor, and Celebrex. Its high profile products treat a variety of afflictions and it has even branched into pet medicine. According to the company's website, Pfizer helps more than 150 million people every year.

Q2 Breakdown
Pfizer is coming off a decent second quarter. it posted a net income of $2.78 billion, or 41 cents per share. This was a country mile north of the $1.27 billion, or 18 cents per share, it earned in the comparable period last year. Not counting one-time expenses it earned 55 cents per share which was a penny ahead of expectations. Strong international sales were credited for the results. (For more read Measuring The Medicine Makers.)

Going forward Pfizer should do well. At present, it's expected to earn $2.37 a share this year and $2.52 a share in 2009 according to Yahoo Finance. That's a head turner in my book given that the shares can currently be had for about $20 and change. Finally, the company pays a dividend. The current yield is about 6.5%. This is the icing on the cake.

The Potential Downside
The general performance of pharmaceutical stocks could hold down the shares. The stock is currently pretty well off its 52-week high of $25.71.

Conclusion
The Dogs of the Dow strategy bases itself on investment in the highest yielding 10 stocks of the Dow Jones Industrial Average. These stocks get to be the highest yielding through a combination of their stable dividend policies and falling out of favor with the market. As the market moves back toward reflecting the full value of the dogs, the strategy can boast sizable gains. However, some of these stocks are dogs for a reason, and no investment strategy should be an excuse to invest in bad stocks. The dogs point us in the direction of high yielding blue chip stocks; from there we should look for the quality picks.

To learn more on this strategy, check out our related article Barking Up The Dogs Of The Dow Tree.


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Tickers in this Article: BAC, C, PFE, T, VZ, MRK, GE, JPM, DD, AIG

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