Posting the strongest annual returns since 1997, the S&P 500 Index gained 32.4 percent in 2013, including dividends. Most of the gain however was driven not by fundamental earnings growth, but by an expanding price-earnings (P/E) multiple, as I pointed out previously.
But if you drill down a bit further and look at the composition of stock market gains last year, you’ll find that more speculative, lower-quality and small-cap stocks outperformed higher quality blue-chips.
Stocks in the S&P 500 Index that pay regular cash dividends again lagged the overall market last year. In fact, if you owned the top 50 stocks in the index sorted by highest dividend yield, you would have earned a total return of just 24 percent during 2013 — 25 percent less than the S&P 500 Index.
But at least one time-honored dividend stock strategy paid off for investors in 2013: The venerable Dogs of the Dow strategy found the scent again in 2013, edging out the S&P 500 in total return with a gain of 34.9 percent, versus 32.4 percent for the index.
|The Dogs of the Dow strategy is easy to follow since it involves just one portfolio rebalanced each year.|
The real question is: Will the Dogs of the Dow keep leading the pack in 2014?
Here’s a refresher on the Dogs of the Dow: This strategy suggests buying the 10 highest-yielding stocks from among the 30 stocks in the Dow Jones Industrial Average.
It’s an easy to follow set-and-forget strategy because it involves just one portfolio rebalancing each year in January, yet has produced market-beating results over the long haul.
The theory is that many of the highest-yielding stocks in the Dow get that way in part due to a depressed share price, boosting the stock’s dividend yield in the process. Eventually, mean-reversion kicks in and depressed stocks rise back near the top of the heap, producing market-beating returns, plus rich dividend income while you wait.
Alas, dogs will be dogs, and in 2012 the Dogs of the Dow gained just 9.8 percent compared to a 16 percent return for the S&P 500 Index. So the strategy doesn’t pay off each and every year. But even though the margin of victory was small last year at just 2.5 percent, that was good enough to make the Dow dividend leaders top dogs again.
And this strategy has been best-in-breed over the long run, too.
The folks at Dow Jones created an index to track the Dogs of the Dow strategy stretching back 13 years. Since inception, the Dow Jones High Yield Select 10 Total Return Index has gained 226.6 percent, outperforming the Dow Jones Industrial Average, which is up 153.3 percent over the same period.
Looking at individual changes in this year’s list, three new stocks are in the dog pound this year:
* Chevron Corp. (CVX),
* Cisco Systems Inc. (CSCO), and
* Microsoft Corp. (MSFT)
These three pedigree stocks join the hunt in 2014, replacing Du Pont (DD), Johnson & Johnson (JNJ) and Hewlett Packard (HPQ), which was deleted from the Dow altogether. The table below shows the best-in-breed Dogs of the Dow for 2014.
Although there are only 10 stocks on the list, it’s a pretty diversified group of household names from a wide variety of industries both cyclical and defensive.
Aside from owning the individual stocks on this list, there are also a few ETFs available that track various dividend stock investment disciplines, including the ELEMENTS Dogs of the Dow Exchange-Traded Note (DOD), which tracks the Dow Jones High Yield Select 10 Index.
Remember, investing isn’t all about capital appreciation; even after a 32 percent gain in the stock market last year, dividends still matter.
True, interest rates have been rising, but the 10-year Treasury bond still yields just 2.95 percent. Several of the stocks on the list above have significantly higher yields, plus you can expect dividends to grow over time. In fact, over the long run almost half the total return from stocks comes from reinvested dividends alone.
Bottom line: Dividend-paying stocks offer both capital gain and cash dividend growth potential that bonds simply can’t match. The Dogs of the Dow may not always be an investor’s best friend, but it’s a user-friendly strategy worth considering for a portion of your investment portfolio.
P.S. Find out which of the Dow Dogs are my personal favorites for 2014 and beyond by visiting the Money and Markets Facebook page.