2020 has been a crazy year for the stock market. After getting absolutely crushed in the first quarter, the Dow Jones Industrial Average (DJINDICES:^DJI) has spent the rest of the year climbing out of a big hole. By mid-December, the Dow was actually up 5% during 2020, and it has recently set new all-time highs.

Because the Dow is so popular, there are several investment strategies that use its 30 component stocks as a starting point. The most famous is the Dogs of the Dow approach, which has a solid track record of actually beating the Dow from year to year over the long run. Even though 2020 has been all bark and no bite for the Dogs of the Dow, there's reason to believe that 2021 will be more promising for canine-loving investors.

2020: Dogs of the Dow vs. Dow Jones

Investment

Price Change in 2020 Year to Date

Dow Jones Industrials

+5.3%

Dogs of the Dow

(10.7%)

Source: Yahoo! Finance. As of Dec. 11.

What are the Dogs of the Dow?

Those looking for a simple way to invest love the Dogs of the Dow because the strategy only requires a single set of trades every year. Every December, you rank the 30 stocks that are part of the Dow Jones Industrial Average as of Dec. 31 by dividend yield. The 10 stocks with the highest yields are the Dogs of the Dow for the year. To invest, you just put equal amounts of money toward buying shares of all 10 stocks. Then you sit tight until the following December.

Dog with paw on a calculator, with money nearby.

Image source: Getty Images.

The appeal of the Dogs of the Dow is that it tends to identify beaten-down, value-priced stocks. Depressed share prices boost dividend yields, pushing those stocks toward the top of the list. Yet because the Dow consists of the strongest companies in the market, most of the downturns that individual component stocks suffer reverse themselves shortly -- often by the following year. That typically produces strong performance among the Dogs of the Dow.

How 2020 muzzled the Dogs of the Dow

Several investing themes worked against the Dogs of the Dow this year. In general, value stocks that pay higher dividends underperformed their growth-stock counterparts, leaving the Dogs at a huge disadvantage.

That showed up particularly in a couple of areas. Energy stocks plunged due to market dynamics and COVID-19-related demand disruptions, sending former Dow component ExxonMobil (NYSE:XOM) and current Dow member Chevron (NYSE:CVX) to losses of 20% to 40%. Even though ExxonMobil got kicked out of the Dow mid-year in 2020, the Dogs strategy has you hold onto it until the end of the year.

Also, the tech value plays among the Dow Dogs dramatically underperformed their healthier counterparts. Neither IBM (NYSE:IBM) nor Cisco Systems (NASDAQ:CSCO) was able to bounce back from tough years in 2019. Both remained down on the year, even as Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) soared higher.

A new set of stocks is coming for 2021

There's reason for optimism for investors in the Dogs of the Dow in 2021. Although many of the Dogs stocks are likely to remain the same, some changes could have ramifications for the Dogs and the rest of the Dow:

  • ExxonMobil is out of the Dow, meaning that Chevron will be the only energy play on the list.
  • Currently, it looks as though Wall Street giant JPMorgan Chase (NYSE:JPM) will be a new Dog stock for 2021, giving the Dogs financial exposure at a critical time for the economy that could produce a recovery in the banking industry.
  • Three new members of the Dow aren't likely to be among the Dogs, but they'll still impact the overall average. salesforce (NYSE:CRM) will boost the tech component, Amgen (NASDAQ:AMGN) will add biotech exposure, and Honeywell (NASDAQ:HON) will increase the core industrial base.

Finally, Boeing (NYSE:BA) and Disney (NYSE:DIS) have suspended their dividends temporarily, leaving the Dow in the unusual position of having some stocks paying no dividends at all. It'll be interesting to see what happens when a recovery gets to the point that Disney and Boeing feel comfortable making payouts to shareholders again.

Every Dog has its day

The Dogs of the Dow strategy doesn't have a perfect track record, and the strategy's 2020 underperformance is one of the worst in recent memory. Just because a strategy doesn't work one year doesn't disprove its value over the long run, though. Investors who like dividend stocks  should keep a close eye on the Dogs of the Dow in 2021.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.