‘Dogs of the Dow’ pay off in volatile market

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The “Dogs of the Dow” have barked loudly the last two years — far outperforming the rest of the stock market in 2011.

Will they repeat their recent success in 2012?

The Dogs are the 10 stocks in the Dow Jones industrial average with the highest dividend yield. The basic premise of the investing strategy is simple: Buy the Dogs at the start of the year. At the end of the year, sell the ones whose yields have fallen out of the top 10.

The popular investing strategy has a mixed track record overall in the 2000s. But its recent success in a turbulent investing environment makes it worth a closer look, particularly because of its reliance on dividends.

The idea is that focusing on the highest-yielding stocks gets you to buy temporarily out-of-favor blue chips — they’re hardly “dogs” — at a time when they might be bargains. That’s because a stock’s dividend yield rises as the stock’s price declines.

But betting on big, dividend-paying companies in general, and the Dogs in particular, seems to pay off in volatile times like these. And it has consistently performed well for the first few years after recessions, suggesting that the run of good showings since the last recession ended in 2009 might continue.

Last year, the Dogs of the Dow posted a total return of 17 percent. They included companies such as AT&T, Kraft and Intel. That far outstripped the 8 percent return of the Dow and the 2 percent return of the Standard & Poor’s 500 index.

In 2010, the Dogs rewarded investors with a total return of 21 percent. The Dow yielded a total return of 14 percent and the S&P 500, 15 percent.

The strategy can work even better if limited to the five highest-yielding stocks.

The Small Dogs, as they’re known, produced a return of nearly 20 percent in 2011. They have beaten the S&P 500 in seven of the last 12 years, and 24 of the last 39 dating to 1973. That slightly exceeds the showing of the expanded, 10 Dogs of the Dow, which have topped the S&P 500 in six of the last 12 years, and 23 of the last 39.

Even when it’s not working, investors can earn significant dividend income. The total return for dividend stocks has been greater than the return of non-dividend payers in all but two years since 2000, according to S&P.

Money manager Michael O’Higgins, who popularized the strategy in his 1991 book “Beating the Dow,” contends that despite the off-and-on results in the 1990s and 2000s, the strategy is still the most reliable way to judge the value of blue chip stocks.

“Dividends are a lot more stable than earnings,” he says. “Earnings are what the accountant says they are. Dividends are cash.”

This year’s Small Dogs, based on current yields: AT&T Inc., 5.9 percent; General Electric Co., 3.6 percent; Merck & Co., 4.4 percent; Pfizer Inc., 3.7 percent; and Verizon Communications Inc., 5.2 percent.

Rounding out the full list of 10 Dogs, the next five are Johnson & Johnson, 3.5 percent; E.I. DuPont de Nemours & Co., 3.4 percent; Intel Corp., 3.3 percent; Procter & Gamble Co., 3.2 percent; and Kraft Foods Inc., 3.1 percent. Eight of the 10 are holdovers from the start of 2011, with Chevron Corp. and McDonald’s Corp. having been bumped by GE and Procter & Gamble.

Consider taking one for a walk.

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Personal Finance Writer Dave Carpenter can be reached at http://twitter.com/scribblerdave .