“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in” John D. Rockefeller
One of the most intriguing strategies in markets is the so-called ‘Dogs of the Dow’ strategy, which was first popularized in 1991 by renowned money manager Michael O’Higgins.
The Dogs of the Dow strategy tells investors to invest annually in the ten Dow components whose dividend is the highest fraction of their price. In other words, you pick the ten Dow companies with the highest dividend yield. You would then reshuffle this portfolio annually to maintain equal exposure to the top-ten dividend performers. In other words, high dividend yield plays.
This strategy is really as simple as it sounds, and only requires an annual review to reassesses the Dow 30 on the basis of their dividend performance.
Why this strategy?
We invest our income with the ultimate objective of trying to maximize our total returns. There are two prominent methods of investing your income, to increase your total returns.
The Returns Formula
Total Returns = Capital Appreciation (Growth) + Dividend Yield
- Capital Appreciation (Growth): Earnings and price of stock increase above market average
- Dividend Yield: Quarterly or Yearly cash payouts for your investment in the company based on performance
Growth and dividend stocks differ in certain ways. This is mainly due to investors having expectations that growth stocks will one day have the possibility of generating high capital gains, while dividend stocks are usually old companies that are stable and less innovative.
A dividend is often the sign of a financially healthy and stable business that is committed to rewarding shareholders. These are some of the qualities Warren Buffett looks for when he invests.
How do we shortlist companies?
A more suitable benchmark for this strategy of investing in high yield dividend stocks will be the NIFTY dividend opportunities 50 Index .
The NIFTY Dividend Opportunities 50 Index is designed to provide exposure to high yielding companies listed on NSE while meeting stability and tradability requirements. The NIFTY Dividend Opportunities 50 Index comprises of 50 companies. The methodology employs a yield driven selection criteria that aims to maximize yield while providing stability and tradability.
The historical data can be found here and the average dividend yield hovers around 2% (twice the Nifty 50 yield).
Alternatively, there are mutual fund schemes from various fund houses that focus on this strategy and we at Prabhudas Lilladher can help you select the best ones out of these (email us at email@example.com)
Good but Don’t Commit All!
One thing everyone should know about dividend yield is this: it doesn’t tell you much. It doesn’t give you clues about the valuation of a corporation, changes in corporate fundamentals, sustainability of the dividend or future returns. It’s just a simple ratio: the current dividend, divided by the price.
Here’s an example: General Electric had a 2.9% dividend yield at the end of 2016. One year later, it had a 3% dividend yield, which is not that much of a difference in yield. But the yield alone conveyed nothing about the deterioration in fundamentals of the corporation, the fact that dividends had been cut, nor that investors lost 45% of their principal in the stock over that year.
A better strategy is to invest in stocks that can not only maintain their dividend, but also continue to grow while doing so.
Also look at the payout ratio. If a company pays out a higher percentage of profits as dividends in select years, then it is more susceptible to a dividend shrinkage should things go wrong in the future. Also, if there is a consistent high payout and the dividend is rising then there is a good chance that the stock may have a higher price-earnings ratio (high stock price) and a lower dividend yield and it may not even figure in your short-listed stocks.