Dogs of the CAPS

I like dogs. They're loyal and friendly. And when it comes to investing, they can indeed be your best friend.

Most investors have probably heard of the Dogs of the Dow strategy. Rank the dividend-yielding stocks from highest to lowest yield and buy the top 10. Hold for one year and a day and sell. Wash. Rinse. Repeat.

Four dog night
The Motley Fool even used to follow a strategy called the Foolish Four, which built on the original strategy by ranking those high-yielders by price -- lowest to highest -- and buying just four of the top five stocks (if the cheapest stock is also the highest yielder, throw it out, because it's probably a real dog). While the Fool abandoned the strategy because of doubts about its efficacy, some sites still track results, and over 25 years it has a pretty impressive record, with annualized gains of 17.7%.

Like I said, I like dogs. The Foolish Four was my first foray into investing in individual stocks, so I've always carried a warm spot for it in my heart. With the Fool's own foray into its newest investor intelligence ratings, I thought maybe Motley Fool CAPS might be an interesting addition to the strategy. More than 85,000 professional and novice analysts have rated more than 5,400 stocks, with the best stocks earning five stars.

Last year I postulated that using a CAPS strategy on top of the Foolish Four might hold some surprises for us, and at the beginning of the year, I began tracking how these dogs are running. We'll continue to track these top 10 dogs to see how they're doing all year long. Here's the list of 2008's Dow dogs and their returns so far.

+ Excludes dividends, commissions, and taxes.

While the 10 Dow Dogs are doing about as bad as the Dow Jones Industrial Average overall, our top-rated dogs -- those that started the year with a CAPS rating of three to five stars -- are doing slightly better. Better, they're both beating the broader market, represented by the S&P 500 index. Unfortunately, it looks like our Foolish Four CAPS Dogs (Citigroup, Pfizer, GM, and Home Depot) stumbled badly in the month of February. However, just as we noted last month when the dog pack was beating the Dow Jones, this is just too short of a time period to judge results. As I'll also reiterate, I would never recommend having this as my whole portfolio, but as part of a well diversified one it might be fun to include the CAPS Dogs.

Gotta go to MO's
Just as February was cruel to investors, the Dow Jones came down hard on Altria: the stock was actually dropped from the Dow Jones Industrial Average. Since it spun off Kraft and plans to spin off its international operations, it was judged as no longer being the industrial representative it once was. Honeywell also got the boot on Feb. 11. They were replaced by Bank of America (NYSE: BAC) and Chevron (NYSE: CVX), the first substitutions since 2004.

CAPS player kahunacfa finds Altria to be just as good of a buy as when he first bought it in 2000:

The stock is slightly undervalued, not deeply undervalued as it was in 2000. Two events make the stock attractive today: 1. [Altria] was removed from the Dow Jones Industrial Average, that potential selling pressure creates a trading opportunity, and 2. Altria will soon spin-off Philip Morris International (March 2008) to long-term shareholders like me. I will keep both pieces, although the growing International Business is more attractive [than] the slowly declining Domestic Philip Morris.

If we add in a point or two of return for getting kicked off the Dow list -- stocks that have been removed from the Dow tend to perform slightly better than those that are added -- Altria may just be a winner this year.

What's it all about, Wolfie?
I'd be remiss if I didn't mention that I no longer invest using mechanical investing strategies like the Dogs of the Dow or the Foolish Four, but I do keep an eye on how they perform, just for nostalgia.

As smart as our Foolish CAPS investors are, this is a contrarian investing strategy that tries to stand market wisdom on its head. I'll keep you posted on how our CAPS Dogs are running.

If you want to get your own CAPS dog in the race, just click here to get started. It's 100% free.