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Tickers in this Article: BAC, GM, C, PFE, T, VZ, MRK, GE, JPM, HD
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 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, but in 2007 the strategy faltered. However, 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)
$29.58
8.65%
General Motors (NYSE:GM)
$11.90
8.40%
Citigroup (NYSE:C)
$18.85
6.79%
Pfizer (NYSE:PFE)
$18.89
6.78%
AT&T (NYSE:T)
$31.40
5.10%
Verizon (NYSE:VZ)
$34.45
4.99%
Merck (NYSE:MRK)
$32.68
4.65%
General Electric (NYSE:GE)
$28.71
4.32%
JP Morgan Chase (NYSE:JPM)
$39.52
3.85%
Home Depot (NYSE:HD)
$23.80
3.78%
Data as of market close July 25, 2008
As alluded to above, the traditional Dog strategy would not be recommended here. Some of these stocks have positive prospects, others 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.

The Best of Breed
I think General Electric deserves some attention this week due to its reorganization announcement. The conglomerate and one time Wall Street darling announced plans to structure itself into four business segments as opposed to six. This is good news as it will make understanding the Connecticut-based behemoth a bit easier for retail and institutional investors alike.

Another thing that piques my interest is that Jeff Immelt, GE's chief executive is under a lot of pressure due to the struggling stock price.

Why is that a good thing? Well, for him I imagine it's not, but it is good for shareholders because it should force him to be creative and to find ways to enhance shareholder value. He may push for asset sales going forward in order to make the company more attractive and to hone its focus.

Another thing I like about General Electric is that it has its hands in so many businesses (ranging from aviation and energy, to healthcare and finance). I mean it truly is, I think, a staple in our society. Now hold the emails folks, of course I realize that this doesn't by any means guarantee its success. However, I think it (again having its hands in so many businesses) does allow it the potential for big growth and to maybe better weather this current economic storm than some smaller companies that don't cast as wide a net. (To learn more about these big companies, check out Conglomerates: Cash Cows Or Corporate Chaos? )

Currently analysts are expecting GE to earn $2.21 per share in 2008 and $2.34 per share in 2009. That's not an overly impressive expected growth rate, but given that the company is expected to grow at an 11% pace per year in the next five years, and the fact that the shares can currently be picked up for under $30, I think it's pretty interesting. (For more on analyst expectations read Analyst Recommendations: Do Sell Ratings Exist?)

The downside here is these is the potential of an earnings disappoint in the third quarter. Also if Immelt and company management aren't aggressive in their drive for shareholder value, the stock could sag.

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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