The Dow Report: Dogs of the Dow
By Tim W Wood CPA, February 18, 2005
On January 29, 2004 I set up a model portfolio using Michael O'Higgins "Advanced Method" of picking the Dogs of the Dow. This method is explained in Mr. O'Higgins book, Beating The Dow and is a buy and hold value investing method with an excellent track record.
Mr. O'Higgins explains in his book that his method was actually made famous by Graham and Dodd. Under this method Mr. O'Higgins would look at book values for each of the 30 stocks that make up the Dow Jones Industrial Average. He would then pick the 10 stocks with the lowest book values for his portfolio. According to Mr. O'Higgins, this method yielded a return of 1,283.39% between 1973 and 1991, while the DJIA itself yielded a return of 559.31%. This method clearly "Beat the Dow."
Graham is said to have been fascinated by the fact that the worth of a private company is evaluated in terms of book value, but when a company goes public, the attention shifts from book value to earnings. I must say that I too, am fascinated by this phenomenon.
Book value is a ratio of a company's stock to its net assets, or book value per share. Book value per common share measures the dollar amount that common shareholders would receive if all assets were sold at their carrying amounts and if all creditors were paid.
This method makes perfect sense to me. But, I reported last year when we set this model portfolio up that the only issue I had was the fact that this method was utilized in a bull market between 1973 and 1991. I was very curious to see if this method would Beat the Dow in a bear market environment, in which I believe we are operating.
Here are the results. On January 29, 2004 when this model portfolio was set up, the DJIA closed at 10,488.10. On February 17, 2005 the DJIA closed at 10,754.26. This was a net gain on the DJIA of 266.16 points or 2.54%. The 2004 Dogs of the Dow portfolio was up 3.95 points for a total gain of 1.27%.
So as you can see, even this very effective method of value investing is not measuring up and I believe that it is a direct result of the fact that we remain, contrary to popular opinion, in a bear market environment.
|Stock||'04 Price||'05 Price||Diff|
|Walt Disney (DIS)||24.50||29.35||4.85|
|Eastman Kodak (EK)||28.93||34.12||5.19|
|Hewlett Packard (HDQ)||24.16||20.86||-3.30|
|J.P. Morgan (JPM)||38.97||36.78||-2.19|
|SBC Communications (SBC)||25.55||24.25||-1.30|
|International Paper (IP)||41.85||38.00||-3.85|
I want to add that this poor performance of both the DJIA and the Dogs comes in spite of the fact that 2004 was the second consecutive year of more bulls than bears as reported by Investors Intelligence. This means that this is one of the most bullish times ever for the stock market in terms of people's expectations for the market, yet a proven method of value investing cannot even beat the dismal performance of the DJIA.
I believe that this extreme bullish sentiment is just what we should expect for this rally. After all, this rally is likely to prove to be the ever so important rally separating Phase I from Phase II of this great bear market and to think that it would not be extreme, has been mistaken thinking. Most people believe that all is well and that the worst is over, thus they are bullish. Yet, we still sit with a number of higher level bearish technical conditions that remain and most people have now even discounted these warnings as well. All the while, the DJIA was up a whopping 2.54% with this very effective method of value investing not even measuring up to the performance of the Dow. This should be telling you that something is wrong and that this is NOT a bull market.
It is now time to setup our Dogs of the Dow model portfolio for 2005 using Mr. O'Higgins Advanced Method. The portfolio is as follows:
|Johnson & Johnson||JNJ||65.65|
|Procter & Gamble||PG||53.33|
We will monitor this portfolio throughout the year and compare its performance to that of the DJIA. The data for this portfolio was take from quicken.com on February 17, 2005.
Tim W. Wood
© 2005 Tim Wood