Dow Dividend Strategy

I hope you enjoyed last week’s post about the Magic Formula approach to stock investing. Beyond putting some time into what that strategy is all about, the work for that approach is largely done for you on the Magic Formula website. So, it is a good option to provide some structure to your investing strategy. I want to profile another strategy this week called the Dow dividend strategy. This approach is very simple and looks to buy Dow Jones Industrial Average listed stocks when they are at point of being undervalued by the market i.e. cheaper than they might otherwise be.

Many of you may be wondering what the Dow Jones Industrial Average is as a first point and what the stocks are to which I am referring. The Dow Jones Industrial Average (DJIA) is a stock market index of thirty major US companies. I guarantee you will have likely heard of all thirty of these companies as they are such big names as Microsoft, Apple, ExxonMobil, The Home Depot, etc. The DJIA consists of the huge companies that are pervasive in our daily life – they feed us, clothe us, run our vehicles, power our homes, entertain us, etc. They are companies that are not going away anytime soon and thus, all things being equal, are considered safe, long term bets for investing. The actual DJIA figure you hear about in the news is taken by adding up the stock prices of the thirty stocks and dividing them by the Dow divisor. The Dow divisor is a number that changes according to stock splits or changes in stock dividend numbers so that there is consistency in how the average is calculated. You don’t need to know all of that information, rather, the most important thing to take away is that the DJIA consists of these mega companies and uses their stock price to come to a figure. The higher the collective stock prices, the higher the DJIA.  The news the DJIA recently hit 26,000 means stock prices of these 30 companies are high (basic math tells us this as if we are adding all of the stock prices together, the higher the price, the higher that number will be) which is good for investors and shows confidence in the economy generally.   

The Dow dividend strategy is simple – find the 10 highest dividend yield stocks once a year and invest in each of the 10 with the money you have allocated. As you will recall from earlier posts, dividend yield is calculated by taking the annual dividend amount and dividing it by the company stock price. You can get all of these figures extremely easily from Morningstar, Google Finance or any other website you choose.  To get started on this strategy, you will write down all thirty companies that make up the DJIA and list them on a sheet of paper. Beside each, you will list its corresponding dividend yield and stock price. After that is complete, circle the top 10 highest yield figures.  The website does all this for you if you don’t want to do the exercise yourself.

Once you get your ten top stocks using the above method, pull them out and put them into a separate chart so you can further consider how you want to invest. Your chart is going to have four columns with the following titles:

Company Name

Stock Symbol

Dividend Yield

Stock Price

Fill in the chart with the applicable information for the top 10 dividend yield stocks from the DJIA.  Jason Kelly, in his book that I have referenced a few times on this site, The Neatest Little Guide to Stock Market Investing (Kelly, Jason. The Neatest Little Guide to Stock Market Investing. New York: Penguin Group, 2012. Print) indicates at page 130 and 131 that there are four popular Dow dividend strategies once you have isolated those top 10 stocks. The strategies are: Dow 10 – buying an equal amount of each of the 10 stocks. If you have $10,000 to invest, you would put $1,000 in to each stock. Dow High 5 – buy the five highest dividend yielding stocks. So, $2,000 in each of those. Dow Low 5 – buy the five lowest priced out of the 10 stocks. Again, $2,000 of each and finally Dow 1 – put all your money into the second lowest priced stock. All $10,000 into this particular stock. Why, you are likely asking would I do this under the Dow 1 strategy? According to Jason Kelly, research has shown the lowest priced stock is often facing genuine trouble but the second lowest price stock is not usually in trouble but is just undervalued at that point. Interesting right? Jason Kelly goes on to discuss the performance of these different strategies and indicates that the Dow Low 5 had the best performance for an annual return.  The Dow 1 had the lowest and is likely not being a good strategy beyond a fringe, speculative type investment strategy.

At the end of the year, do this exercise again and sell the stocks that are no longer in the top 10 grouping (perhaps only three or four) and buy the ones that have now entered in the top 10 grouping. If you have more money to invest, like say another $5,000, divide that amount by 10 and put $500 extra into your new portfolio of 10 stocks (noting that 6 or 7 of the stocks will likely be the same as the ones from last year so you will just top those up). I like the simplicity of this strategy and the fact the figures are all readily available for consideration. That, along with the fact that the stocks consist of 10 of the largest companies in the US, makes this a very attractive investment strategy. After reading about the Magic Formula and now the Dow dividend strategy, which do you tend to prefer?

** Top photo courtesy of Dmitri Popov on Unsplash