Here is what happened when we applied the renowned stock-picking method 'Dogs of the Dow' to the Sensex
07-Oct-2020 •Danish Khanna
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:
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.