FA Center: These ‘Lucky 13’ dividend-rich stocks are better bets than the ‘Dogs of the Dow’

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Dividend-seeking investors often go to the dogs in January. Dogs of the Dow, that is.

The famous Dogs of the Dow strategy is perhaps the most widely-known approach to investing in high-dividend-yielding stocks. It calls for investing each January in the 10 Dow Jones Industrial Average DJIA, +0.88%  stocks with the highest yields, and holding them until the following January. Many investors now are determining which stocks these would be, and whether the strategy’s track record is good enough to justify investing in them.

My research suggests that there is a better way. But I first want to give the Dow Dogs its due. It took the world by storm in the early 1990s, on the strength both of a good historical record and its elegant simplicity. It called for transactions to occur on just one day each year, and required no complex analysis of either company balance sheets or technical chart patterns. Most investors could have done worse than follow this approach.

Nevertheless, dividend-seeking investors would fare better by following the approach recommended by Investment Quality Trends, edited by Kelley Wright. According to my performance tracking, this newsletter has the best record of any dividend-stock strategy I monitor, and significantly better than the Dogs of the Dow. In fact, Wright’s newsletter is in first place for risk-adjusted performance over the last 30 years among all services that I track.

Wright believes the Dogs of the Dow strategy suffers from two major flaws. The first is that it focuses on absolute yield rather than relative yield. That’s a problem because a given yield can indicate undervaluation in the case of one stock and overvaluation in the case of another. As a result, investors shouldn’t automatically invest in the highest-yielding stocks.

Wright’s solution is to compare a given stock’s yield only to the range of its own past yield. A stock is considered undervalued only if it’s trading at or close to the high end of that range — regardless of whether that yield is above or below those of other stocks.

The second major flaw of the Dogs of the Dow strategy, according to Wright: It makes no accommodation for the possibility that a stock’s dividend is about to be cut. In such a case, of course, far from indicating undervaluation, the high yield is a warning sign that the stock should be avoided. Just recall what happened last year to General Electric GE, +0.05%  , for example.

Wright’s solution to this second flaw is to restrict his analysis to just those stocks that satisfy a demanding set of financial strength criteria. His criteria are sufficiently stringent, in fact, that eight of the 30 Dow stocks don’t even qualify. Specifically, he focuses only on those stocks satisfying at least five of the following six criteria (as enumerated in the January issue of Investment Quality Trends):

•        Dividend increases 5 times in the last 12 years

•        S&P Quality Ranking in the “A” category

•        At least 5 million shares outstanding

•        At least 80 institutional investors

•        At least 25 years of uninterrupted dividends

•        Earnings improved in at least seven of the last 12 years

Though there still is no guarantee that a company that meets these criteria won’t cut its dividend, it is relatively rare.

The proof of the pudding is in the eating, of course. Consider first an exchange-traded note that mechanically follows the Dogs of the Dow strategy: The ELEMENTS Dogs of the Dow ETN DOD, -5.32%   which was created in late 2007. Over the 10 calendar years from 2008 through the end of 2017, as you can see from the accompanying chart, the ETN on a net asset value basis essentially equaled the 8.6% annualized return of the broad market (as measured by the Wilshire 5000 index, including dividends).

In contrast, Wright’s so-called “Lucky 13” portfolio produced a 10.4% annualized return over this same period, or nearly two percentage points better per year. Though Wright has a two other model portfolios that have slightly outdone his “Lucky 13” portfolio, it is the one most analogous to the Dogs of the Dow since it also involves just one transaction each year, in early January.

One measure of the difference between Wright’s approach and the Dogs of the Dow is that currently just two of the 10 Dow Dog stocks are part of Wright’s “Lucky 13” portfolio: Coca-Cola KO, -0.02%   and IBM IBM, +0.49%  . Furthermore, of the 11 other stocks in the “Lucky 13” portfolio, just one — Walt Disney DIS, -0.54%  — is even part of the Dow 30.

The 10 other stocks in the “Lucky 13” portfolio are:

•         Cracker Barrel Old Country Store CBRL, +1.96%

•        Eaton Corp. ETN, +0.77%  

•         Franklin Resources BEN, +0.62%  

•         Hormel Foods HRL, -0.27%  

•         Lowe’s Companies LOW, +2.16%  

•         Omnicom Group OMC, +1.56%  

•         Philip Morris International PM, +0.80%  

•         Texas Instruments TXN, +0.77%  

•          TJX Companies TJX, +2.28%  

•         Weyco Group WEYS, +0.09%  

For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com .