Does the Dogs of the Dow strategy work in Australia?

The Dogs of the Dow is a term for the worst-performing stocks in the Dow Jones Industrial Average (NYSE: DJI). The index has 30 stocks that represent the industries and businesses that are driving the US market. The S&P 500 Index (NYSE: SPX), on the other hand, is made up of the 500 biggest companies by market capitalisation.

The Dogs of the Dow investing strategy is to buy into the worst-performing stocks of the index because, the theory goes, short-term bad performance would mean that they would perform better in the near future, and you picked them up at a discount.

Looking at the S&P ASX 50 Index (ASX: XAF) for an Australian comparison here, over the past one year some of  the worst performers are seen some tremendous declines, while others fell more on the level of a regular correction.

Newcrest Mining (ASX: NCM), the gold miner, has the unenviable spot at the bottom, or should I say top, of the dogs of the ASX 50. It is now at $7.69 a share, back to a level not seen since August 2003.

At that time gold prices were around US$360/ounce, and the mining and housing boom was just taking off. Now at US $1,252/ounce, that is not too much above the US$1,001/ounce all-in sustaining cost it announced in its September 2013 quarterly report. Over the past year, the share price is down 70%, and about 40% lower than its book value of $12.97 in 2013.

WorleyParsons (ASX: WOR) is down 33% over the past 12 months, and the majority of that drop occurred on November 20 when the share price fell 25.89% as it announced that it expected profits to June to be $260 million to $300 million, rather than the previously forecasted $320 million.

The engineering company has been hit with slowdowns in mining domestically, and its Middle East and Latin America businesses are also experiencing lower revenue due to a downturn in the minerals and metals markets. In Australia, many mining services companies are reporting profit downgrades, and it may take some time before the big oil and gas projects can take up the slack, and power the mining services industry out of its slump.

The fertiliser and explosives producer Incitec Pivot (ASX: IPL) came out with its annual results up to September 30, showing a net profit was down 27% to $372 million from $510 million in 2012. The company said it was mostly due to a higher Aussie dollar and low global fertiliser prices.

Its share price rallied for several days after the November 12 announcement, yet came back to rest at $2.59 on Friday, continuing its recent downtrend which started in mid-March. Explosives revenue makes up about 57% of the yearly total, and the scaling back of the miners means subdued sales from that industry. In total, its share price is down 17% over the past year.

Foolish takeaway

The Dogs of the Dow model is more speculative in that assumes that eventually the companies will right themselves, and by buying them when they are cheapest, investors will get a decent return.  There’s no real time frame on this, and it is possible that market conditions could change in the near term, but it’s not a reason to run out and buy stocks like these.

I would much rather study them, find out what is making them weak or fall in market sentiment, and note them for further investigation. If those conditions begin to improve, then you may be onto something. This is how you learn a company and its industry’s business cycle.

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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