2023-12-27 09:26:38 ET
Summary
- The annual Dogs of the Dow are out! This is the list of the 10 highest-yielding stocks within the 30 stocks in the Dow Jones Industrial Average.
- To me, each year these "dogs" tell me a lot about what is likely to be worth researching and "hunting" in the equity market in the year ahead.
- DJD is an underfollowed Dogs of Dow-like ETF that deserves more attention than it gets. I compare it side by side with SCHD, a very popular dividend ETF.
Given the number of excellent dividend-focused investors who gather and exchange ideas on Seeking Alpha, I may not have to explain the Dogs of the Dow concept. But for those who are not familiar, here's a summary :
The Dogs of the Dow refers to a stock-picking strategy that uses the ten highest dividend-yielding stocks from the Dow Jones Industrial Average ( DJIA ) each year. The Dogs of the Dow strategy, a long-term investment strategy, was popularized by American money manager and author Michael B. O’Higgins in 1991.
Just like any index or collection of stocks grouped into a "basket," the Dogs of the Dow are followed as a strict rules-based portfolio by some. But I think the value in it is through using it as an input to a broader dividend portfolio of stocks, ETFs or both. In a "past life" as they say, I was the lead manager of a mutual fund that aimed to own dividend stocks and rotate them, based on a method I created, to generate as high a yield as market conditions would allow, with capital preservation as a key dual mandate. Long before that time, I was a dividend stock and ETF aficionado, enough to have created an indicator that evaluates stocks based on their dividend history.
Pavlov's Dogs of the Dow?
That's why, when this last week of the year rolls around, market watchers like me have a bell ring in their heads, akin to Pavlov's dogs. Except in this case, the dogs are those Dogs of the Dow! So since it is that time of year, and the 2024 Dogs of the Dow are established, I'll do two things here:
1. Analyze the new Dogs of the Dow, the 10 stocks in the Dow 30 with the highest yields at year-end
2. Make the case for an underfollowed ETF, the Invesco Dow Jones Industrial Average Dividend ETF ( DJD ), a relative Chihuahua at $320 million in assets compared to the wildly popular Schwab U.S. Dividend Equity ETF ( SCHD ), with its $50 billion in investor assets.
Here are 2024's Dogs of the Dow. Note that most of them are the same as last year's list. Intel ( INTC ) and JPMorgan ( JPM ) are gone, and Cisco ( CSCO ) and Coca-Cola ( KO ) are in. The other eight stocks are the same. Given the strong performance in 2023 of the two stocks exiting and the lagging returns of the two that entered, it makes sense.
As for the rest, they reflect what we saw in 2023 very well: a very narrow market for most of the year, with tech leading the way and the Magnificent 7 members of the Dow, Apple ( AAPL ) and Microsoft ( MSFT ) being serially low yielders who have not qualified for this list in a while. What this does reflect is that there are many high-quality businesses that are stable but not spectacular, and they yield much more than the 1.4% yield of the S&P 500 Index.
To me, the more likely course for the US stock market in 2024 is that we'll see something we did not see in 2022 or 2023: solid relative performance by the stocks of cash flow-rich businesses over the so-called "long duration" stocks that require one to buy into the narrative of high future earnings growth, then hold their breath and hope the stock grows into the lofty valuation.
Next, let's take a look at the updated Dogs of the Dow using past performance. With an average 2023 return of around -3.7%, and an average 3-year total return of under 7% (total over the three years), plus the yield-stock nature of many of these names to begin with, it is no surprise they are back for another year on this list.
Some investors would stop reading right here and say, "the Dow is an old-fashioned way to track the stock market. The S&P 500 is the US market benchmark now." I'm not old enough to remember when the S&P 500 debuted (1957), but I have been around long enough to remember when the Dow, not the S&P 500, was "the market." In the 1987 crash, it was the 500-point Dow collapse that made the headlines.
Fast-forward to today and the S&P 500 is clearly the most popular US stock market benchmark. Yet 45% of the S&P 500 is also in the Nasdaq 100, the highest degree of overlap on record. Furthermore, the S&P 500 has become, like the Nasdaq, an index driven by a small number of stocks. To be clear, I am as big a fan of "concentrated investing" as you will find anywhere. But with the S&P 500's biggest holdings, they are too related by the "Magnificent 7" aura to make me think that index is a good representation of the total US economy and business landscape as the Dow continues to be.
Even with the Dow's quirky price-weighting allocation system, those 30 stocks give me a better picture of what the "stock market" is doing and where it can go as looking at the top 30 stocks by weight in the S&P 500 index. That's just my take, and I know it is a highly unpopular one in an era where ETFs linked to that index and the Nasdaq 100 dominate the inflows and DIA is an afterthought.
That brings me to the Seeking Alpha quant grades for the updated Dogs of the Dow. The overall scores are middling, as are their collective valuation, growth and momentum grades. Investors are hard-pressed to find mega cap companies selling at low teens P/E multiples as small cap and non-US stocks typically do today. So my views here are relative: in other words, I like the Dow-type stocks much more in 2024 than the Nasdaq/S&P 500 biggest weightings.
But what really stands out here is the Profitability Grades for these 10 stocks. Eight A+ ratings, an A and a single C rating. THAT is where I'm looking at this and thinking that after a messy 2022 for all stocks, a strong 2023 for some, 2024 might just be the year where the 2-year laggards revert to the mean.
And while Microsoft and Apple are common to all of those indexes, and Microsoft is a strong 6.6% of the Dow currently, Apple is only a 3.4% weighting. This article will not dive into the implications of that, but another one soon probably will.
DJD: an ETF that runs with the big dogs (of the Dow, that is)
So, if you like the Dogs of the Dow concept, and you like their relative position heading into 2023, you have several options. One is to buy the 10 stocks in whatever weighting you wish. That's your call, not mine.
The other is to get more familiar with DJD. And in an effort to also educate investors about the risk of "hero-worship" in ETF investing, I decided to stack DJD up against the $50 billion, low cost, strong past-performance behemoth I'm often ridiculed for referring to as "overrated." To be clear, SCHD is a fine ETF. And by that I mean it is OK. But I just don't see the reason for it to be so highly-favored over a set of other dividend ETFs, especially when different parts of the dividend stock space tend to go in and out of favor.
In growth stock markets, dividend growth will likely win out. In bear markets, high quality wins. In falling interest rate environments, high yield stocks win, as long as they are not ticking time bombs, with yields that look nice and high, but are vulnerable. Frankly, that case could be made for one or two of the Dogs of the Dow, but again, that's beyond the scope of this article.
I have conversed politely with enough folks in the Seeking Alpha comments section to realize that SCHD is two things:
1. An ETF whose holders are very dedicated to it
2. An ETF whose holders may not be as aware of the risks to its approach going forward
My goal is not to talk anyone out of SCHD, because my opinion is just that, an opinion. But I've seen a wide enough variety of markets and spent 37 years understanding what makes them tick at different times. And so when I see that there are many quality dividend ETFs like DJD and others I will soon write about, but relatively no one considers them, I figure it is time to speak out.
The table below shows that DJD and SCHD have been back and forth depending on what trailing time period you look at. The past three years is probably the most telling period on this quick table, since it includes some big ups, big downs and in betweens. But SCHD romped over DJD during 2019 and 2020, the two years that are in the 3-year and 5-year periods below.
But as I have noted many times in my articles and the comments section, trailing return or annual (calendar year) past performance is probably the least useful data point one can use in this type of analysis, and easily the most misleading. For nearly four decades, I've seen investors get suckered into buying what just went up the most, or sticking with funds because they convinced themselves they were better than they were. Sort of like seeing a new quarterback for your football team, and when he has a few good games, assume that it will continue for years.
It is hard for investors to separate what "feels good" (owned something and it has done well) versus what the market climate was and is, and how they are different. I am pretty convinced that 2023 and 2021, the last two glorious up years for large cap US growth stocks, are less likely to be repeated too often during the next 5-10 years. So I try to impart some experience in seeing a dozen or more such shifts since the 1980s.
I do that knowing that many won't care or will even mock the effort. But that won't stop the open-minded folks from learning from the insight. None of us can predict the future, but we can be ready for major changes in what markets reward, and that's the intention here.
DJD's lower asset base is spread across 30 stocks (the Dow 30) and they are weighted in descending order of dividend yield, which is in the spirit of Dogs of the Dow, but with two key differences:
* It owns 30 stocks not 10
* It weights them according to yield, whereas the Dogs of the Dow are typically weighted equally (10% each if one were creating a portfolio with that strategy).
As you can see above, DJD is concentrated the way I like my ETFs. I prefer to know what I own and track it as if I owned the stocks directly. So having 10 of them account for more the 3/5 this part of my portfolio allocation is just fine. SCHD is quite concentrated for an ETF with 100+ holdings, but only 2/3 as focused as DJD.
Below we see that on a 1-year rolling return basis, the two ETFs are similar. SCHD went flying out of the pandemic low in mid-2020, and as shown here, flew past even SPY for a period of time. This is apparently one of the historical periods where the legend of SCHD was born.
Below, we see that DJD has had an advantage over the past 12 months, outperforming SCHD by about 3.75%. To that I say, "so what?" That's not the point here. I'm not cheerleading for DJD here as much as saying that if one likes the Dow Dogs idea, DJD is going to target it better than any other ETF I know of.
We also see in the lower part of the chart that DJD and SCHD have been true peers when it comes to volatility and consistency of returns, based on their nearly identical standard deviations over most of the past half-decade.
Summary points
The Dogs of the Dow have been refreshed for 2024, and the message I get from it is that there are still some US blue chip stocks that have the potential to make up some of the ground they have lost in the post-pandemic investment fever that has made modern markets what they are: totally nuts compared to the past! But I think the drumbeat for those traditional blue chips that are found in and around the Dow Jones Industrial Average is getting louder. Maybe the FAANG tree can go to the sky, but I think that's a bigger risk than looking more toward profitable companies trading at more reasonable multiples. DJD sells at about 16x earnings.
As for SCHD, I get it. It is a solid dividend ETF. I just think it is overrated, when we consider how many other dividend ETFs are out there, including one with the see-through ability of DJD's highly concentrated portfolio. I rate DJD a Buy on a relative basis to the S&P 500, which I think is the only way to evaluate large cap equity ETFs when so much of the market tends to rise and fall together (thank you algorithms and indexation!). As for SCHD, on that same basis, it's a Hold to me. I don't consider it for my portfolios as I do DJD, but it is of the nature that it should also be competitive with the S&P 500 if and when the obsession with a small number of giant stocks finally reverses meaningfully.
The Dogs of the Dow is somewhere between quirky, interesting and legendary, depending on one's personal investing history. To me, it is still one of the best annual rituals to track, to keep me centered and make me think about where the US stock market stands as the annual calendar turns.
For further details see:
Dogs Of The Dow For 2024, And Why DJD Is Outperforming SCHD