How to utilize a High Dividend Yield Strategy

The world today is facing an unprecedented economic uncertainty with the confluence of many global events – a potential hike in interest rates, inflation at multi-decades high and de-stabilisation sanctions of Russia.

With that in mind, many investors are fleeing ‘risk-on’ tech stocks and opting for safer assets like dividend stocks and gold. One of the popular strategies that have withstand the test of time and financial crisis is none other than ‘Dogs of the Dow’ strategy.

We will explain more about the high dividend yield strategy and attempt to replicate that to the local market.

‘Dogs of the Dow’ strategy explained

The Dogs of the Dow refers to a stock-picking strategy that uses the 10 highest dividend-yielding, blue-chip stocks among the 30 components of the Dow Jones Industrial Average (“DJIA”). This strategy will require a portfolio rebalancing at the beginning of each calendar year.

The term “Dogs of the Dow” was first coined by Michael B O’Higgins in his 1991 book - Beating the Dow. The premise is that investing in stocks paying the highest dividend yields on the Dow Jones Industrial Average will yield better results than investing in the index as a whole.

These stocks are called “dogs” because they tend to be unloved by the investing community and are theoretically near the bottom of their business cycles. They can usually offer higher yields because their share prices have performed relatively poorly but their strong balance sheets allow them to continue paying decent dividends.

How to Employ this Simple Strategy

As mentioned above, the Dogs of the Dow is a simple strategy to follow and it is relatively safe as the universe is limited to only blue-chip stocks. There are only 3 steps to employ this strategy as shown below:

Step 1: At the beginning of the year, look up the top 10 dividend-yielding stocks on the Dow. Allocate your capital equally among the ten stocks and hold the positions until the year-end.

For example, an investor with a portfolio of $100,000 would allocate $10,000 to each of the top ten dividend-yielding stocks.

Step 2: At the end of the year, re-ascertain the top 10 dividend-yielding stocks on the Dow.

Step 3: Rebalance by selling your positions and re-allocating the capital into the new top ten dividend-yielding stocks determined in Step 2.

For example, if the portfolio is now worth $120,000 (20% gain), the investor would sell his positions and re-allocate $12,000 to each of the new top 10 dividend-yielding stocks on the Dow.

And that’s it - this strategy is intended to be a low-maintenance, long-term strategy that mimics the performance of the DJIA. On top of that, your investments will be centred around those companies with the highest dividend yields, making it a great choice for investors looking for income.

Singapore’s Dogs of the Dow

The next question that investors may wonder is that whether it is possible to apply the Dogs strategy elsewhere i.e. the Straits Times Index (“STI”) Index.

Technically, the answer is that we can do that. However, the results may vary widely because the profile and sectors of the Dow Jones stocks are very different from that of the STI 30 components which comprises mainly of REITs and financial institutions.

For some perspective, I picked up 10 local stocks with the highest dividend yield and compute their 5 year total shareholder returns as shown below:

Despite REITs/Trusts comprising 7 out of the 10 counters, their returns come up to a respectable 8.64% annualized return (including dividends). That also compares very favourably to the STI Index’s paltry returns of 0.93% (excluding dividends).

Conclusion

The high dividend yield is inherently a conservative strategy, because you are investing into renowned blue-chip stocks with high dividend yields.

It is also relatively simple to implement when you only need to perform yearly rebalancing on the first and last days of the year.

Amidst all the global uncertainty going on right now, this high yield strategy may appeal to many income investors who can also take on slightly higher risks for the concentrated portfolio.

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