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Good Dog!

Investing in stocks considered the dogs of an index won't have you chasing your tail.

Even to the most unaware and uninitiated, this year is the year of the stock. As the Dow Jones Industrial Average (DJIA) and the Standard & Poor's 500 (S&P 500) Index effortlessly vault through record after record, investors in search of a bargain have begun to wonder if there is anything left to buy low and at what price should they sell high? In a market full of greyhounds, how do you find the laggards? They say every dog has its day, and for value-oriented investors, the solution can be found as close as the nearest pound . . . by investing in some "dogs," that is.

We're not talking about adding just any old mongrel to your portfolio. The idea is to buy the 10 DJIA stocks that currently sport the highest yields--the "dogs of the Dow." The trick is to buy equal amounts of these 10 stocks and hold them for a year. After 12 months, you'll reassess your holdings, replacing lower-yielding stocks with those that are the current year's dogs.

These stocks are referred to as "dogs" because although the underlying companies are well-established and have high dividend yields, they have fallen out of favor and their prices have been driven down. It is hoped that although they are beaten down at the moment, they will enjoy a turnaround and do better in the future. Since we wrote about it two years ago, investors have poured hundreds of thousands of dollars into the Dow Dividend Strategy (DDS), as it is known, effectively forcing themselves to buy low and sell high. Of course, there is no assurance, nor does this imply, that the stocks are being bought at the bottom and that they'll move up from there.

Through the DDS, investing in the dogs of the Dow allows investors to focus on household-name companies with long histories. By emphasizing the 10 highest-yielding stocks rather than the 10 DJIA stocks with the highest dividends, the DDS aims for enhanced total return from both capital gains and dividends. How does it work? Consider that yield is an inverse indication of a stock's popularity. As a stock's price rises, its yield falls. Look at it this way: Yield=annual dividend/stock price.

If ABC Corp. pays a $10-per-share annual dividend and the share price is $50, ABC's yield is $10 divided by $50, or 20 percent. If the share price of ABC rises to $100 while the dividend remains the same ($10), the new yield is 10 percent. At first glance, the drop in yield seems negative, but what has actually happened is a bonanza: capital gains and income, a pedigree worth having. Compared to other investment strategies, investing in the Dow's dogs is easy.

A variation on the theme, the Low 5 Dow Dividend Strategy limits the portfolio to the five highest-yielding stocks. Investors choose the five lowest-priced stocks of the DDS on the day their portfolio is established. Again, the portfolio is held for a year and all dividends are reinvested. Whichever strategy is selected, ideally investors continue it, adjusting positions annually for the life of their "pet," for at least one complete market cycle of three to five years. Both strategies are considered to be long-term strategies, which should be made with the understanding of the risks associated with common stocks.

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This article was originally published in the October 1997 print edition of Entrepreneur with the headline: Good Dog!.

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