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How the Dogs of the Dow Are Faring in 2014's Pullback

By Dan Caplinger - Feb 6, 2014 at 12:30PM

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The Dow Jones Industrials are down substantially this year, but one popular strategy has led to smaller losses. Find out about it here.

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The Dow Jones Industrials (^DJI 0.88%) continued their volatile performance Thursday, with stocks up 154 points as of 12:30 p.m. EST, after significant losses earlier in the week. Yet the blue-chip index is still down substantially for 2014. That has some income-seeking investors taking a closer look at a popular dividend-stock strategy known as the Dogs of the Dow.

Under the Dogs of the Dow strategy, investors look at the top 10 yielding stocks in the Dow at the beginning of the year and invest equal amounts in all 10. Investors then hold those stocks until the end of the year, at which point a new set of Dogs is chosen based on new dividend yields. In 2013, the strategy produced gains of 8 percentage points more than the change in the Dow, with a yield that was almost a full percentage point higher than that of the index overall. But is the strategy working this year?

Source: Wikimedia Commons, courtesy Geo Swan.

A mixed breed of Dow Dogs
On the whole, the Dogs of the Dow are outperforming the Dow Jones Industrials slightly. As of last night, the Dogs were down just 5% for the year, compared to a nearly 7% drop for the average. Obviously, that's not perfect performance, but it does meet the expectation that defensive dividend stocks will outperform aggressive growth stocks in a market downturn.

Yet the overall performance of the Dogs of the Dow hides some of the crosscurrents in the market. The top two Dow Dogs are AT&T (T 0.78%) and Verizon (VZ 0.79%), and both of those stocks have posted losses as the companies engage in an increasingly competitive price war for their wireless-plan services. Started by rival T-Mobile, the back-and-forth discounting and promotional offers have raised big questions about whether the wireless business will eventually end up being like the landline business. Many phone users can't remember the days when expensive per-minute long-distance call charges cost some customers hundreds of dollars in landline fees, but the same forces that brought that pricing power to an end might eventually cost AT&T and Verizon their growth prospects as well.

The Dow Dogs also include two of the three stocks that have posted gains so far this year, and both of them are in the pharmaceutical industry. Merck (MRK -0.19%) and Pfizer (PFE -2.78%) are trying to take maximum advantage of the opportunities available in Big Pharma right now, and investors are excited about new drug prospects and collaborative partnerships that could finally help the companies emerge fully from their patent-cliff contractions in recent years. Those gains are a big part of why the Dogs are doing so well in 2014.

What's next for the Dogs?
Obviously, early results don't guarantee that the Dogs of the Dow strategy will keep outperforming the Dow Jones Industrials. But the strategy does shed some light on how dividends can often help shelter investors from the worst of a short-term share-price decline.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$33,602.34 (0.88%) $292.91
AT&T Inc. Stock Quote
AT&T Inc.
$18.15 (0.78%) $0.14
Merck & Co., Inc. Stock Quote
Merck & Co., Inc.
$89.02 (-0.19%) $0.17
Pfizer Inc. Stock Quote
Pfizer Inc.
$48.56 (-2.78%) $-1.39
Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
$45.20 (0.79%) $0.35

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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