The dogs of the Dow are in the doghouse

Are these stocks ready to bounce back?

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When it comes to managing your money, the name of the game for millions of investors is keeping it simple. That's the big appeal of an easy-to-follow investing strategy called the Dogs of the Dow.

Later in this article, we'll look at how well the Dogs of the Dow have performed so far in 2012. But first, let's fill everyone in on how the strategy works and why some investors count on it to give them better returns than the entire Dow Jones Industrial Average (INDEX: ^DJI) can provide.

You've gotta have dividends, dog
Dividend stocks have been more popular than ever in recent years. Especially in the aftermath of the financial crisis, the security of getting cash paid to you every three months makes it a lot more comfortable to invest your hard-earned money. But no one wants to pay too much for an investment — even for a high-quality dividend stock.

That's where the Dogs of the Dow strategy comes in. Every year, you look at the 30 stocks in the Dow Industrials and sort them by dividend yield. Take the 10 with the highest yields and invest equal amounts in all of them. It's hard to imagine a simpler strategy, and it gives you stocks that both pay solid income and offer relatively reasonable valuations.

That combination paid off for investors in 2011, as the Dogs of the Dow easily outperformed the broader Dow. But how's the strategy working so far this year?

All bark, no bite
Unfortunately, the Dogs of the Dow don't always outperform the overall Dow, and 2012 is shaping up to be a poor year for the strategy. So far, the average Dow Dog stock has seen its price rise by about 6%, which is behind the Dow average's performance by 2 full percentage points. The underperformance is even worse if you use an equal-weighted return for the Dow, expanding to more than a four-percentage-point gap. Although average yield on the Dogs is more than a percentage point higher than for the broader average, that's not enough to make up for the shortfall.

Why aren't the Dogs of the Dow delivering the goods this year? You can blame it on a number of things:

  • The two most influential stocks among the Dogs, Johnson & Johnson and Procter & Gamble (NYSE: PG) , have both seen price declines so far this year. J&J has had huge difficulties rebounding from a long series of product recalls that stretch back for years. Meanwhile, P&G has faced high materials costs as well as mandatory price controls in Venezuela, which it blamed for its dreary outlook for full-year earnings.
  • None of the top five performers in the Dow is included among the Dogs. With Bank of America (NYSE: BAC) — which has the worst yield among the Dow 30 — leading the way in total return so far this year, the Dogs already find themselves in a big hole.

Who'll let the Dogs out?
But don't count the Dogs of the Dow out yet. Among the Dogs, Intel (Nasdaq: INTC) andDuPont (NYSE: DD) are the best performers, and they may very well have a lot more room to run.

For Intel, the big question is whether the company can finally deliver on chips that will make a real dent in the mobile-device market. After largely ceding the mobile market to its competitors, Intel now realizes that it can't depend on its dominance in the PC arena to produce long-term growth in the face of a major shift in the way that people use computing devices. It'll take a while for Intel to ramp up, but with many investors pessimistic about Intel's chances, the stock has some upside if Intel succeeds.

Meanwhile, DuPont has done an excellent job focusing on chemicals for which it has pricing power. In particular, titanium dioxide, which is used in a huge range of products from paint and toothpaste to sunscreen, has been a big growth driver for DuPont. Moreover, even though the company is already the largest supplier in the world, it plans to boost its capacity with new titanium-dioxide plants that should make it even more dominant in the industry.

Get out of the doghouse
Even though the Dogs of the Dow aren't beating the market, 2012 still has a long way to go. It's far too early to count out the power of dividends in providing strong performance.

One important outcome from yesterday's rates decision is that bank deposits continue to be less and less attractive for investors seeking income. We think that's where shares can play an important, but often overlooked role. To find out why, and see which shares we think fit the bill, look no further than "Secure Your Future with 3 Rock-Solid Dividend Stocks". In this free report, we've put together our best ideas for investors who are looking for solid companies with high dividends and good growth potential. Click here now to find out the names of our three favourite income ideas. But hurry – the report is free for only a limited time.

Take Stock is The Motley Fool Australia's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691).

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