Dow Jones & The Dog Theory
The Dow Jones industrial average is a benchmark. It is composed of 30 of the largest companies in the world. A benchmark means that it is used as a indicator to tell how well the markets are doing in general. The Dow is quoted at almost every market open and close by reporters.
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History
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On May 26, 1896, Charles H. Dow unveiled his industrial stock average, now known as the Dow. Two-thirds of the Dow components are manufacturers of industrial and consumer goods. The Dow is not only seen as an indicator of how markets are doing, but it is even considered to be an indicator of how the general economy is doing.
Returns
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If you study the markets in general, you will notice that not all asset classes stay at the top, year over year. The same can be said for individual stocks. In fact, solid companies that may not do well this year will generally correct problems and do better in the following years. This is not guaranteed but can be observed with different companies.
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The Dogs
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A contrarian approach to investments postulates that companies that correct this year, or lag the markets, will do better next year. Companies that do not do well in the Dow this year are known as the Dogs of the Dow. Since the price decreases, or doesn't appreciate as significantly in years when the market is up, these companies will have a higher dividend yield.
Significance
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The reason people buy the Dogs of the Dow is twofold. First, they have the opportunity to appreciate. Secondly, they have a significant dividend payout, which means you can collect income whether the share price goes up, down or stays the same.
Conclusion
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Just like any other market strategy, the Dogs of the Dow has a risk that it may or may not work. If you looked at the performance from inception in 1973 to 1996 you would see that the Dogs of the Dow returned 17.7 percent, while the Dow returned 11.9 percent. Yet in 2008 and 2009, the Dow itself outperformed the Dogs.
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References
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