I’ve been thinking about this:
The ‘Dogs of the Dow’ strategy.
The theory of this strategy is that the Dow Jones Industrial Average companies are among the best run companies in the world. Companies fight to get on this list. But even good companies have bad days. As a data point, such stocks pay dividends. This is a bribe to convince investors of their success. Like antlers on elk. For dividends to advertise success, they tend to be as stable as possible. This means that when the price drops, the dividend / price ratio rises. This is not only easy to calculate, it is a standard measure which is widely reported.
The basic strategy is to take a small group of highly selective stocks, such as the Dow, and every year invest in one third of them with the highest dividend / price ratio. Recalculate every year and repeat.
This is an attempt to be both objective and lazy. This assumes we live in a murky world where we will never have enough accurate data, but that the hard truths cannot be successfully hidden for long.
Immediately drop any stock which drops or greatly reduces its dividend. The whole point of an elk’s antlers is to advertise health and confidence. If it can not make the show, it cannot be presumed to be of great vitality. Note that this is the reason to favor the divided/price ratio over the price/earning ratio. Earnings can be jiggered and if a stock does not produce a dividend it is immediately brought to your attention.
This does not work for stocks such as Amazon which try not to pay dividends. One could make the case that not paying dividends is a way to hide information. That they are building a glamour, and so should be avoided. If dividends cease their role in the business milieu this will need to be changed. Perhaps to the price/earning method.
I do not recommend doing this with large indices such as the Standard and Poor 500 because they are not selective in the first place. There is little of a mean to revert to, and most of the companies have not established a reputation which may persist past the era of a charismatic founder.
The varieties of this strategy are endless: Once can use other red flags for failing performance than loss of dividend. One may use one’s own method of choosing a set of elite stocks. One may invest in two thirds of the stocks in a bull market and one third in a bear market. Just remember that you are using the wisdom of the market to hopscotch your own ignorance and emotion. As Feynman said,’The problem is you are the easiest one for you to fool.’
A dozen or so years ago two brothers who picked stocks came up with an extreme version of this strategy. They suggested buying your own stock and only investing in the four with the worst year. Of course it failed. The ‘Foolish Four’ was too few stocks and the occasional stock, such as GE, which would drop off of the list would certainly be among the stocks you chose. If a stock is dropped off the DJI once a decade, then you will both get the badly performing stock and miss the new one which was doing so well ast to get on the DJI.
If one believes the people who choose the new stocks for your index, then perhaps one should always hold the new stock for a year or two. Take advantage of their catabolism to establish their presence. Then again maybe just for a short period, then treat them as the others.
Well that’s about it. Do you have any comments?