Dogs of the Dow this Year — Winners Next Year!

Market overreaction is an opportunity for contrarian investors. For short-term reasons the ‘dogs’ are often down

The Dogs of the Dow is an investment strategy which became popular in the early 1990s. In its original version, investments are made at the end of the financial year into the TEN highest-yielding stocks of the Dow Jones Industrial Average or DJIA (total of 30 companies). The portfolio can be held for any specific time, but the strategy usually performs the best during January of the following year.

Why Dogs of the Dow Works?

The answer is simple: Tax Optimization.

Financial textbooks don’t tell you that the average investor can sometimes be highly irrational. This irrationality can be due to an unexpected event in the markets and can tend to be directed at specific institutions/persons for no particular reason. People generally hate paying taxes and the Internal Revenue Service (IRS), for that matter. So much so that they have consistently sold losing long positions near the bottoms to minimize their tax bill in the current year.

Unbelievably, even when told this might not be a good idea, people hate paying taxes so much that they gladly forgo potential profits in the future for the chance of minimizing their current tax bill. The notion of the ‘rational investor’ is generally a myth. Indeed, the fact that the Dogs of the Dow works is strong evidence that investors can exhibit irrational behavior either indefinitely or, for a very long time.

Our Version of the Dogs of The Dow

The world has changed. Dividend yield ranking is probably a bit outdated – many stocks such as Apple (AAPL) are returning money to shareholders via stock buybacks with most of their profits rather than dividends. In our view, the essential criteria should not be dividend yield but YTD returns. Here are ALL the 16 losers in the Dow for 2022:

Step 1 – Initial Selection

Step 2 – Sensibility Test

As mentioned above, our most significant criterion would be YTD return. However, there are other criteria. We will apply the reasonability test. Given With the abundance of losing components in the Dow, investors have plenty of choices. Based on experience, we will exclude V, AXP, DOW, and PG – the YTD losses in those stocks are insufficient to generate much tax optimization selling.

Step 3 – P/E Ratio Application

We will apply the P/E ratios of the remaining companies (according to Yahoo Finance):

Step 4 – Remove P/E Outliers

We will exclude companies with negative P/E ratios and those with excessively high ratios. Thus, we will remove BA (negative PE), DIS (57 PE), and CRM (282 PE), and the following ten companies remain:

Step 5 – Portfolio Construction

If you are concerned about long exposure or do not have the mandate to be long only, you can short dollar-for-dollar exposure with the DIA ETF. We will allocate 10% of the capital to EACH stock (the original version of the Dogs of the Dow). Instead of waiting for the last day of the year, every business day we will AVERAGE our entries with their closing price (or near it) in December 2022.

Step 6 – Exit Strategy

We intend to exit the portfolio during the last week of January – 26.01.2023- 30.01.2023, which we will do proportionally. 20% of the portfolio is to be closed each day. We will try to close our positions at the closing price or near it every day.

Sources:

Slickcharts
Yahoo Finance

Disclaimer: