The Dow Dogs! My Spin On An Old Investment Strategy...

Many of you who are investment savvy are familiar with an old strategy known as "The Dow Dogs". If you are currently unfamiliar with this strategy, see the Wikipedia definition here.

The basic idea behind the Dogs of the Dow is to take individual stocks from the Dow Jones with the highest yields. Yield is the percentage of the stock price which the company pays out in yearly dividends. As the price of the stock declines, theoretically, the yield increases. The idea behind this strategy is that stocks in the Dow with the highest yields indicate that these stocks are currently undervalued.

A few years back, I ran across an article on MSN Money that had an interesting spin on this strategy. Here is a link to the article. I will not bore you with the theory of this strategy in this space, if you're interested, please read.

In the past few years, I have used my own spin on the Dogs of the Dow. The strategy that I use is to setup a stock screen (I love stock screens, and since switching to E-Trade always use theirs. In the past, I used the one on MSN, which you can find a link to under the "Links" tab of this blog.) with the parameters: 1) Component of > "DJIA", 2) Price/Cash Flow (TTM) > "Below Industry Average", and 3) Insider Activity Over The Last 1 Month > "Net Accumulation".

Let's go through the screen step by step. First, Dow Jones Industrial Average (DJIA, or DOW) membership is comprised over 30 stocks, seen to be as significant. These stocks, for the most part, are large cap growth companies, and seen as safer investments than smaller cap stocks. Second, the price to cash flow ratio provides a measure of relative valuation. Cash flow refers to the actual cash generated per share of stock outstanding, and is a superior measure than price to earnings (PE), because it removes non-cash transactions from the equation which sometimes cloud the valuation picture. Finally, the most interesting piece, Net Insider Accumulation. The theory behind the inclusion of this metric is that insiders of the company know the company best, and can recognize when the stock price is undervalued. This is a similar play on the "New Dow Dogs" theory which I posted the article to above. Furthermore, the screen in E-Trade keeps this metric more up to date (it uses the past month) than the screen talked about in the article (which uses company buybacks over an ENTIRE YEAR).

As of the first of the year, the screen returned three stocks, AT&T (ATT), Verizon (VZ), and General Electric (GE). The yield on the three stocks, as of this writing, are 5.97%, 5.73%, and 2.64%, respectively. To go one step further, I like these stocks for the following reasons: ATT - increased market share due to the iPhone, VZ - gaining market share on Comcast in the cable spectrum, and I believe they will get the iPhone sooner rather than later, and GE - I think will become more profitable as credit conditions and conditions in the financial sector continue to improve (GE is a big player here).

In a subsequent post, I will be setting up a fictitious $10,000 portfolio of investments which I think will perform well. I think this will be a fun exercise for both me and my reader, and will update on the progress of this experiment frequently. I will be including my three "Dow Dogs" in this portfolio when I start it, so you can all see what type of returns such a strategy can produce related to other investments and the market as a whole. As always though, do your own research and due diligence.

Until later....