The Dow Jones Industrial Average (DJIA) or the Dow is an index of 30 companies that many investors are confident about investing in. It shows the market valuation of companies such as General Electric, Exxon Mobil and Microsoft Corporation and is a good reflection of how the markets are performing. A common strategy used by traders when investing in the Dow is the ‘Dogs of the Dow’ strategy.
This strategy involves a trader buying the top 10 stocks with the highest yield from a bucket of 30 stocks in the Dow. The idea behind this strategy is that blue-chip stocks with a high dividend yield is a sign that these companies are currently facing a downturn in their business cycle and in the upcoming year these values are sure to increase as the company goes through its cycle.
What is the DJIA?
The DJIA or the Dow is one of the most famous and trusted indices in the world. Founded by Charles Dow during the 19th century, the DJIA assesses the value of a basket of 30 blue chip companies based in the United States. Blue-chip stocks are shares of large, well-recognized companies that have a high valuation and a long history of trading on the stock market.
Here are the 30 stocks that make up the Dow Jones Industrial Average as of today.
|AXP American Express||107.74|
|DWDP DowDuPont Inc||53.23|
|XOM Exxon Mobil||79.03|
|GS Goldman Sachs||196.7|
|HD Home Depot||185.14|
|JNJ Johnson & Johnson||136.64|
|JPM JPMorgan Chase||104.36|
|PG Procter & Gamble||98.55|
|TRV Travelers Companies Inc||132.91|
|UTX United Technologies||125.67|
Usually, when people say ‘the market is doing well’, they are most likely referring to the DJIA. The index also provides valuations for certain industries such as the Dow Jones Utility Average and the Dow Jones Transportation Average. Other famous indices like the DJIA include the S&P500 index which is an index that values 500 companies.
How is the DJIA calculated?
The DJIA calculates the value of 30 blue chip companies whose valuations have a large influence on the economy and are a good reflection of the current market conditions. The companies that are to be included in the DJIA are selected by editors of The Wall Street Journal.
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When valuing the companies, the Dow only considers the average price of the stock and not the company’s market capitalization. Hence if both company A and B have a stock price of $40 but their market capitalizations are $30 million and $90 million respectively, as per the index calculation both companies will have the same impact on the market and the movement of the DJIA.
But the DJIA index differentiates between stock splits, spin-offs etc using a divisor. Before the divisor, the total value of the stock prices was divided by the total number of stocks. However, if there was a stock split in one of the shares, dividing it by the total number of shares will not provide an accurate value of the DJIA.
With the divisor, the value of the stock will be calculated as follows:
Say a stock has a share price of $50 that is split into two and the total sum of all the 30 stocks in the bucket is $1096. The first step will be to subtract the split stock from the total: 1096-25= $1,071.
To find the new divisor after the stock split you need the new sum by the index value before the split. Therefore: [1071/(1096/30)]= $29.32 (new divisor)
The new DJIA= 1071/29.32= $36.53
Why is the Dogs of the Dow strategy great for investors?
Using the calculation shown above the DJIA provides the valuation of 30 large companies that have a high market valuation and provide an accurate reflection of the market conditions. The Dogs of Dow strategy, introduced by Michael B. O’Higgins in his book Beating the Dow, picks the top 10 companies out of the 30 included in the index based on their dividend yield. The Dogs of the Dow are a list of the current 10 companies ranked by their yield in the prior year from highest to lowest. The dividend yield is the ratio of the total dividends paid out to shareholders to the market value of its shares. Therefore companies with a high dividend yield pay out a large amount of their revenue in the form of dividends.
The Dogs of Dow is an optimal strategy for many investors as it ensures that they receive a high return on their investments. Many investors usually pick stocks based on the number of dividends they receive and buying the stocks with the highest dividend yield (10 Dogs of the Dow) will ensure that the investor earns a good return.
Furthermore, as the dividend yield of a company increases, it signifies that a company is facing a downturn in their business cycle and as all cycles have their ups and downs, buying a Dogs of the Dow stock with a high dividend yield is a sign that the company will have an upward movement in the upcoming year. Stocks that are currently going through a slump tend to have a low share price that is attractive to many investors.
What companies are the Dogs of the Dow in 2019?
Historically, the Dogs of the Dow stocks have shown positive returns for investors. In 2015 and 2016 they had price gains that beat out the Dow but faced a low point in 2017 as they only had returns of 19% in comparison to the Dow’s 25%. In 2018 however, the current Dogs of the Dow faced losses of 4% that were still significantly lower than the losses faced by the Dow at 6%. While this strategy does not always promise returns, it is appealing to many investors as the high yielding stocks usually have a lower price and is a safer option to buying all 30 stocks in the Dow.
Here are the top 3 Dogs for 2019:
— Exxon Mobil: The price of oil per barrel has increased steadily during 2018 from $60 per barrel to $70 per barrel but ended the year at only $45 a barrel. This is a sign that Exxon Mobil may have an upward turn in its stock prices in 2019. Two factors that can lead to better market conditions for Exxon are the ongoing talks between the US and China along with a cut in oil production by OPEC nations. The second factor is Exxon’s aggressive growth plan that hopes to double their returns in the upstream and downstream business.
— Pfizer: Pfizer’s popular pharmaceutical drug Lyrica had a dip in sales in 2018 and lost a lot of market share in the U.S and Europe. However, with a change in management this year, Pfizer is more optimistic about 2019. Moreover, the company has more than 30 drugs in the pipeline that it hopes to receive approval for by 2022.
— Cisco Systems Although there has been an increase in Cisco’s dividend in the last few years, many investors are choosing to invest in younger tech companies, leaving older companies like Cisco behind. However, Cisco plans to rectify this issue in 2019 as they are turning all their subsidiary services into subscription models which they hope will help them leverage their position in global markets and increase revenue. They also have a 3% yield which is a high value in comparison to other DJIA companies.
Also read: Here Are the 2019 Dogs of the Dow
The Dogs of the Dow strategy is great for investors to diversify their portfolio and receive above-average returns. While the current Dogs of the Dow stocks may not seem to be doing well in the market currently, they are sure to increase in value by the end of the year.