"Bulls make money, bears make money, but pigs get slaughtered" is an oft-quoted Wall Street saying. That may be, but in 2003 these Pigs truly brought home the bacon, returning 51% and doubling the return of the Dow Jones Industrial Average. In 2004 the strategy did not fare quite so well, but it still outperformed the Dow and easily beat the Dogs of the Dow strategy.

The Pigs originated when I decided to track the five worst-performing Dow companies of 2002. My selection criterion was percentage of stock price decline. The idea was to hold these -- Pigs of the Dow -- for a year, sell them, and reinvest the proceeds in the five worst-performing Dow companies of 2003.

Sounds like the Dogs of the Dow, you say? These Pigs are no Dogs. In 2003, the Dogs returned 23.6%, which at first glance seems like a good year. Yet these mangy curs failed to beat the Dow index, while my porcine beauties doubled the Dow by returning 51%!

The Pigs of the Dow differ from the Dogs of the Dow and the Foolish Four strategies, both of which select companies based on those with the highest dividend yield at the end of the previous year. It is my premise that there are not enough Dow companies paying a significant dividend and that a strategy based on previous year's stock price decline would yield better returns.

For example, in 2002, Intel's (NASDAQ:INTC) stock price was cut in half, the second-worst decline of all Dow companies. In 2003 it more than doubled, making it 2003's best-performing Dow company. However, Intel pays such a minuscule dividend that it could not qualify for the Dogs of the Dow. The lowest of the top five dividend yields in the Dow is 3.7%. There's a wide disparity with the highest yield of the bottom five of just 0.79%, and none of these companies is ever likely to qualify for the Dogs of the Dow.

For 2003 the Pigs were Eastman Kodak (NYSE:EK), AT&T, Merck (NYSE:MRK), SBC Communications (NYSE:SBC), and Johnson & Johnson (NYSE:JNJ). They collectively declined in value by an average of 15.2% during 2003. Below is a table of their 2004 individual performance compared with the Dow 30 and the Dogs of the Dow. All figures exclude dividends.

2003 Loss

Share Price

12/31/04 Share Price* YTD Gain
EK -26.7% $25.67 $32.25 25.6%
T -23.3% $20.03 $19.06 -4.8%
MRK -18.4% $46.20 $32.14 -30.4%
SBC -3.8% $26.07 $25.77 -1.2%
JNJ -3.8% $51.66 $63.42 22.8%
Pigs -15.2% 5.1%
Dogs -2.8%
Dow 30 +25.3% 10,453.9 10,800.3 3.3%
* Both Eastman Kodak and AT&T, along with International
Paper, were dropped from the Dow 30 in April 2004. They
were replaced by Pfizer, Verizon, and American International

Both the Pigs and the Dogs suffered from Merck's sudden withdrawal of arthritis pain drug Vioxx. I estimate that this affected returns by approximately 5% or 6%. Even so, the Pigs trounced the Dogs yet again and beat the returns of the Dow, thereby lending some credence to the strategy.

Last year the Kua 'Aina Partners discussion board did help me check back to 1998. During that time, the Pigs of the Dow had an average annual advantage over the Dow 30 index of 1.9% and an average advantage over the Dogs of the Dow of 4.1%. It doesn't seem much in the grand scheme of things, but compounded over several years that's a significant advantage.

Which companies are the contenders for Pigs of the Dow this year? The 2004 five worst-performing stocks were:

  • Merck at minus 30.4%
  • Intel at minus 27.0%
  • General Motors at minus 25.0%
  • Pfizer (NYSE:PFE) at minus 23.9%
  • Coca-Cola (NYSE:KO) at minus 17.9%

In his December 2003 book titled Winning With the Dow's Losers, Charles B. Carlson espouses exactly the same theory -- that buying each year based on the previous year's stock price decline will outperform the Dow. However, Carlson conducted far deeper research than my little experiment and researched figures all the way back to 1931. He calculated that such a strategy would have outperformed the Dow by an annual average of 1.2% over that time.

I still prefer my own research because what this strategy often misses is the best-performing Dow stocks and completely ignores other potentially great undervalued stocks outside the Dow 30. Also strategies such as those that the Dogs, Pigs, and the old Foolish Four require do not account for the frictional costs of brokerage fees and the tax costs of changing the portfolio each year. I tracked the Pigs of the Dow because it is a plausible strategy. However, to me the major flaw in the strategy is that companies do not simply become undervalued at year's end. Great companies can be undervalued by the market at any time of the year. The arbitrary nature of the sell decision may also be getting you out of a great company just in time to miss out on the next upswing in price appreciation. One last thought -- just because it was a Pig or a Dog last year doesn't mean that it can't be one next year!

To me what really is important is the idea of searching for value in the market's castoffs, a strategy that I use in my Inside Value newsletter and outlined in Hunting for Value Part 1 and Part 2. If this strategy appeals to you, why don't you try out Inside Value, with the first 30 days on me? No charge. There, you will be able to join the Value Team and me in our discussions and access all current and previous issues. We can talk about the market, your favorite value picks, and those on my current Watch List.

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This commentary was first published on Feb. 19, 2004. It has been updated.

Philip Durell is the analyst for the Motley Fool Inside Value newsletter. His wife owns shares in Home Depot.