GONE TO THE DOGS? CRITICS ARGUE CONTRARIAN BET ON THE
DOW'S LAGGARDS IS DOOMED
By Dolores Kong
The Boston Globe
While surfing Web investing sites a couple of years
ago, Stephen Lepley came across some investing
strategies promising to beat the Dow Jones industrial
average, with the offbeat names Dogs of the Dow and
the Foolish Four.
"You were starting to hear things on the Internet
about the Dogs of the Dow. I researched it a little
bit. You knew you weren't going to go broke if you're
doing this," said Lepley, 43, of Greenfield, who
monitors investing sites from his home computer and
posts his own investing Web page.
So, like hundreds of thousands - if not millions - of
other investors, Lepley jumped on board, attracted by
the chance to beat the Dow.
These contrarian strategies invest in the most
battered stocks of the 30 big-name companies that make
up the Dow, with the expectation that they'll turn
around within a year and outperform the index as a
whole. The Dogs invest in the 10 stocks with the
highest dividend yields, often the lowest-priced of
the 30. The Foolish Four chooses four stocks using a
yield and price ratio.
But the popular Dogs of the Dow severely lagged the
index the last two years, and aren't showing much more
life this year. Meanwhile, the related Foolish Four
slightly trailed the Dow two out of the last three
years and are in their third revision since they were
first described several years ago by the Motley Fool
in books and on the Internet.
"The Dogs and the Foolish Four - it was a fad. And
there are other fads today," said Lepley, who works
for ISO New England, the region's independent
electrical system operator. Although his Foolish Four
account made a double-digit profit the year he was in
it, it lagged the index, so he stopped following the
strategy last year. He now has his low-six-figure
portfolio only in mutual funds.
Joe Waters, 32, of Newton, almost bought into the Dogs
of the Dow himself last year after receiving a "very
slick marketing piece" from Charles Schwab about its
new offering following the strategy. But when he
sought advice on an online discussion board at
Morningstar.com, "the responses I got from people were
kind of pessimistic," said Waters, a salesman for an
Internet start-up. "For a long time now, it's been
kind of underperforming."
Are the Dogs permanently in the doghouse, and are the
Foolish Four little more than fool's gold? Some
critics say the Dow Dogs are too popular a strategy
for their own good or are doomed to the bottom of the
heap because they're old-economy stocks. Others say
the Foolish Four are nothing more than a statistical
But supporters of these strategies say the Dogs will
have their day again. The stakes are high, with
billions of dollars invested in these and other Dow
Feeding and tapping into the interest:
- Big financial services companies including Merrill
Lynch, Morgan Stanley Dean Witter, and Charles Schwab,
which now offer ways to invest in the Dogs of the Dow
strategy through so-called unit investment trusts and
individual stock brokerage accounts.
- The Motley Fool, which touts the Foolish Four on its
Web site and elsewhere.
- Popular books that highlight some form of a Dow
dividend strategy, with such titles as "Beating the
Dow," "How to Retire Rich," and "Investing Secrets of
- Mutual fund companies, which sell products with
names such as the Leveraged Dogs fund.
- Web sites with such addresses as
www.dogsofthedow.com and www.topthedow.com.
The frenzy began with the book "Beating the Dow,"
first published a decade ago by Michael B. O'Higgins
and John Downes. In it, money manager O'Higgins and
financial writer Downes describe a beat-the- market
method of identifying the 10 Dow stocks with the
highest dividend yields, and then buying equal dollar
amounts of the five lowest-priced of those 10. Hold
them for a year and repeat the process.
The rationale behind the strategy, also known as a
contrarian or value-oriented approach: By investing in
the highest-yielding, lowest- priced Dow stocks,
you're buying out-of-favor big-name companies in the
hopes they'll come back into favor during the year in
which you hold the portfolio. (Since the yield is a
result of dividing a stock's cash dividend into the
stock price, a high yield suggests a beaten-up stock
The "Beating the Dow" strategy became so well known
among investing circles that Barron's financial weekly
newspaper popularized the phrase "Dogs of the Dow" to
describe it and regularly updates readers on the
strategy's performance. Although O'Higgins and Downes
focused on buying the five lowest-priced of the 10
highest- yielding Dow stocks, most followers of the
strategy buy the 10 highest-yielding stocks.
O'Higgins, a Miami money manager, now thinks the Dogs
don't have any legs.
"It became too popular," he said, plus the strategy
currently features what he calls "some real dogs,"
such as International Paper and DuPont, each down more
than 20 percent so far this year.
Instead, O'Higgins has a new strategy, described in
his latest book, "Beating the Dow with Bonds." The new
strategy's indicators have led him to put his
O'Higgins fund 100 percent into long-term Treasury
zero-coupon bonds. His fund is up around 11 percent so
far this year while the Dow is down about 8 percent.
(Last year, the fund was down more than 20 percent, he
said, while the Dow was up more than 20 percent.)
Also critical of the Dogs of the Dow, but for other
reasons, is the coauthor of another new book,
"Investing Secrets of the Masters."
"The argument that's raised against the Dogs of the
Dow these days: The universe of stocks on the Dow has
a lower yield than in the past," said William Donovan,
a Massachusetts financial journalist who coauthored
the book with money manager Charles Babin. "The
argument is the yield has shrunk because of the
turnover of companies in the Dow. I think that's a
Among the relatively high-yielding stocks recently
booted out of the Dow: Sears, Chevron, and Goodyear.
Replacing them were low- yielding Home Depot and
Intel, and no-dividend Microsoft. Since the Dogs of
the Dow strategy is based on buying high yields, some
critics say these changes in the Dow have caused the
Dogs' recent dismal performance.
In their book and on the Web site topthedow.com,
Donovan and Babin describe another Dow dividend-based
approach they say isn't affected by such changes, and
which they say has historically outperformed both the
Dogs and the Dow. The "Total Return Portfolio"
approach uses both growth in dividend payments and
yield to come up with the 15 Dow stocks to own.
There's no shortage of critics of these investing
approaches. But there are still plenty of others who
continue to carry the banner.
Tim Mahoney, chief investment officer for Merrill
Lynch's Defined Asset Funds, which include the Select
Ten unit investment trust that holds the Dogs of the
Dow, said "Select Ten is a valid and good strategy"
that can be an important part of a diverse portfolio,
representing the value investing style.
"In the early part of the year, certainly you'd say
value stocks had not done very well. In 1999, growth
outperformed value. But look at it now," he said,
explaining that the Nasdaq is off more than 30 percent
from its high. Now, "value has been outperforming
growth," in the sense that value stocks are down less
than growth stocks since the beginning of the year.
Merrill Lynch is the main sponsor of Select Ten, but
other companies including Salomon Smith Barney and
PaineWebber also offer it. The minimum investment is
$250. Fees amount to 2.75 percent. Select Ten now has
about $9 billion in assets, down from $12 billion at
the end of last year, largely as a result of
redemptions, according to Mahoney.
Another diehard Dogs fan: Pete Grosz, founder of the
dogsofthe dow.com Web site.
"It's a value investment strategy. I think a portion
of your investment would do well by it. It's good for
diversification," said Grosz, a California-based
online publisher who has personally invested using the
strategy since the early 1990s and launched the Web
site in 1995. The free site has grown to more than
20,000 subscribers, and Grosz just launched another
investing site, chartoftheday.com.
As for the Dogs' recent poor performance, Grosz said:
"As we say on the Web site, there will be some years
that the Dogs will underperform. Right now, with the
market's attention turned toward tech stocks, it's
flowing away from value stocks. But we wouldn't expect
that would last forever. So that's why we stay put,
and the value stocks have just become a greater value
relative to the tech stocks and high-growth stocks."
Once just a slight variation of the five
high-yielding, low- priced Dow stocks strategy, the
Foolish Four now uses a ratio that takes into account
low price and high yield, by dividing the yield by the
square root of the price.
Ann Coleman, portfolio manager for the Foolish Four,
said the four stocks selected using this formula are
"beating the market right now, minus 1 percent vs.
minus 3 percent," as of late May. While that's "not
really something to write home about," she added, the
historical data going back to the 1960s show the
stocks fitting this formula each year do substantially
better on average than the overall Dow, the original
Foolish Four, and the Dogs of the Dow.
But in a 1999 article in the Financial Analysts
Journal titled "Mining Fool's Gold," and in an article
this year in the American Association of Individual
Investors journal, Brigham Young University associate
professors Grant R. McQueen and Steven R. Thorley
criticized the Foolish Four for being nothing more
than a statistical trick known as data mining.
"You sort by yield, then by price, take the four
lowest, then throw out the second highest, and when
the moon is full and you tap three times on your chin.
. . . If you look hard enough, you'll find it," said
McQueen in an interview.
"Just for fun, we played that game," he said. "We
created what we called the Fractured Four. The Foolish
Four [an earlier version] outdid the Dow on odd years,
not even years. So tongue in cheek, we tweaked the
The result: The Fractured Four trounced the overall
Dow, the Dogs of the Dow, and an earlier version of
the Foolish Four, up by 34.82 percent on average
between 1973 and 1996. "Obviously, it's absurd,"
McQueen said. He also said he was suspicious about the
way the Foolish Four has been redefined three times.
Portfolio manager Coleman defended the latest Four,
saying it is not a result of data mining but a
refinement in response to the historical data.
"All the changes were a result of more data, better
data to look at," said Coleman, who has been a
journalist, technical writer, and Motley Fool
publications and customer service manager. She also
studied finance for a year.
McQueen remains unconvinced. Whether it's the Foolish
Four or some other variation of a Dow dividend
approach focusing on five, 10, or 15 stocks, "my
common-sense advice is watch out, they're not very
diverse, they force you to trade a lot, and they don't
always manage your taxes very well."