As with many aspects of life, it's possible to have too much of a good thing with your investments. When it comes to dividends, for example, many investors make a big mistake by immediately gravitating to the highest-yielding stocks they can find.
One popular strategy looks specifically at the top-yielding Dow stocks. Known as the "Dogs of the Dow" method, the strategy has you buy the stocks in the Dow that have the highest yields at the beginning of the year. These stocks remain in your portfolio throughout the year, and you replace them at the end of the year with whichever stocks are then the highest yielders in the Dow.
Unfortunately, that method hasn't had the best track record. In 10 of the past 16 years, it has underperformed the Dow itself.
One reason is that the highest-yielding stocks in the Dow tend to be in the same industries year after year. For instance, AT&T and Verizon have once again been named the top two Dogs of the Dow for 2013, marking the fourth consecutive year they've led the list. Moreover, looking further back at history, telecom stocks have consistently been among the top yielders of the Dow over the years.
But both AT&T and Verizon have much different businesses than they did when they joined the Dow. The days of utility-like legacy landlines are largely over, and both companies have now become primarily mobile network giants. At the current pace of technological innovation, both AT&T and Verizon have to make huge capital outlays to support their growth. Recently, that has worked out well for the two stocks, as the revolution in mobile devices has given them pricing power almost to name their own price for data plans. Yet unlike their landline networks, which served them well for generations, mobile networks that adequately handled customer loads for a short period can become obsolete in the blink of an eye as new devices continually test their limits.
Similarly, you'll find pharmaceutical stocks Pfizer and Merck in the top five Dow Dogs for the past three years, as well as at various times in past years. Yet those current high yields reflect vast uncertainty about the future of Big Pharma. Investors foresaw years in advance that both Pfizer and Merck would have blockbuster drugs coming off patent, and share prices fell in light of that uncertainty, boosting dividend yields. Recently, these companies have seen their shares move higher as they've taken substantial steps to replace the huge revenues they've lost to generic competition. Yet if those efforts prove to be less effective than Big Pharma companies hope, then yields will eventually fall due to future dividend cuts rather than further gains in share prices.
So if the highest-yielding stocks aren't the right place to find the truly best Dow dividend stocks, where should you look? Click below to discover the names of three top Dow stocks that have truly stood the test of time.