In the US markets, 'Dogs of the Dow' is a famous stock-picking method. First published in 1991, this strategy aims at beating the Dow Jones index by selecting high-dividend-yielding stocks from the index itself. We wanted to check if this strategy will work in India also, so we devised the 'Dogs of the Sensex'.
What are the dogs?
One of the oldest and widely followed indices in the world, the Dow includes many US blue chip companies. Most of these pay dividends on a regular basis and don't prefer reducing them as they believe that dividends represent their actual worth.
According to Dogs of the Dow strategy, at the beginning of every year, money is invested equally in the top 10 dividend-yielding companies from the 30 companies of the Dow. This is done by rebalancing the portfolio at the beginning of each calendar year and thereafter reallocating the money to the 10 highest-dividend-yielding companies.
The logic behind this strategy is that in contrast to dividends, stock prices are more volatile and tend to fluctuate throughout the business cycle. This may imply that companies with high dividend yields may be near the bottom of their business cycles, which may result in a steep appreciation in their share prices as the cycle turns. Thus, the rationale is that an investor should generate high returns by reinvesting in these high-dividend-yielding companies every year. This strategy has been able to beat the Dow on average over the last 10 years.
The charts below depict the performance of the 'Dogs of the Sensex' vis-à-vis the Sensex.
Here are some key observations:
- In the last seven out of 10 years, Dogs of the Sensex underperformed the broader index. It gave a total return of 15.2 per cent in 10 years as compared to 60 per cent of the Sensex.
- In the first two years post 2010, the strategy provided superior returns as compared to the Sensex. However, post 2014, it managed to beat the Sensex only once.
- PSU stocks have featured regularly in the Dogs of the Sensex as they tend to have high dividend yields and have also underperformed since 2014. The PSU index has been down by more than 35 per cent since May 2014. For instance, ONGC has been part of the Dogs for all 10 years. But its 10-year return has been -11 per cent compounded annually. Apart from this, Coal India has been a part of the Dogs portfolio since April 2012. Until 2020, it has delivered an annual return of -10.5 per cent.
Takeaways from the study
This analysis signifies that a strategy that is successful on a particular index or asset may not produce similar results when applied to another. Similarly, a strategy that may provide superior returns in the USA may not work in India, owing to differences in the dynamics of both the financial markets.
Lastly, the stock-price movement is a function of growth in both earnings and dividends. Therefore, being low on one aspect may not produce the desired results. Investing in high-dividend-yielding stocks should not be the only consideration when it comes to investing in a company. An investor must look at the long-term prospects of the company to make the right decision.