“Dow Jones Index Dogs” and the less well-known “S&P Dogs” are stock picking strategies that focus on the Dow Jones Industrial Average and S&P 500 Index. At the beginning of each year, investors select stocks with the highest dividend yields (usually the top 10), allocate an equal amount of capital to each stock, and rebalance each year by replacing stocks that no longer meet the criteria. This article is the first in a three-part series on trading ideas for these “dogs.” On its own, Dow Dogs is an attractive strategy because it is simple and systematic. In some ways, it is similar to the “CliffsNotes” approach to basic investing techniques. While simplicity is elegant, sometimes it involves making assumptions that may or may not be valid. First, the “dog” approach assumes that the underlying index represents mature “blue chip” companies. Second, this strategy assumes that high dividend yielding companies in the index are only temporarily out of favor and that prices are likely to recover (return to the mean), resulting in capital appreciation and steady dividend income. Third, it assumes that perhaps a portfolio of only ten stocks is sufficiently diversified, although this approach may introduce potential selection bias by focusing on dividends. Famed value investors Benjamin Graham and David Dodd agree on a key premise of this approach: One should adopt contrarian thinking and bet on “nothing” that the market has undervalued due to temporary setbacks. Popular” stocks and expect the “mispricing” to correct over time. However, they don’t simply look at dividend yields to determine which stocks are mispriced. Instead, they advocate an in-depth analysis of financial metrics, including price-to-earnings ratios, book value and intrinsic value, as well as the quality of the assumptions used to calculate them. By definition, underperforming stocks are unpopular, so screening in this way should avoid overbought stocks. However, stocks may decline as fundamentals deteriorate, so we must apply additional shielding. Key Considerations in Choosing Unpopular Names One criterion worth considering is revenue growth. Over the past 10 years, S&P 500 companies’ revenue has grown at an average annual rate of about 5.1%, consistent with average nominal gross domestic product (unadjusted for inflation) growth of about 4.6% over the same period. Of course, revenue may fluctuate due to cyclical effects. Industries closely tied to commodity prices are a good example. Still, if we can use smoothing mechanisms to estimate long-term trends, we prefer companies that grow as fast as the overall economy and inflation. Another criterion that shouldn’t be ignored is earnings and free cash flow growth. Earnings growing faster than revenue indicates high demand for a company’s goods or services and limited competition. Conversely, if earnings fail to keep pace with revenue growth, it could be a sign that the industry is becoming more competitive, squeezing margins. Margins in mature and competitive industries may be narrow (if they are stable), which is fine, but shrinking margins may be more challenging because predicting future earnings may be more difficult. Regardless, a company with declining revenue, earnings, and free cash flow may not even be able to maintain its current dividend, let alone increase it to keep pace with future inflation. Therefore, it should be viewed with skepticism. To illustrate the pitfalls of focusing solely on dividend yield, consider the table below, which represents the 10 stocks with the highest dividend yields in the S&P 500. or faster than) economical, one of the criteria I mentioned. In other words, the remaining eight countries are shrinking in real terms. Walgreens, the stock with the highest yield, doesn’t even have an investment-grade credit rating, with the lowest being BBB-. Vici Properties and Crown Castle are both real estate investment trusts and are obligated to pay 90% of taxable income to maintain that status. This explains their high dividends. Of the two, Crown Castle operates action towers, and despite long-term revenue growth, 2025 revenue is expected to decline for the second consecutive year. In short, simply picking the 10 stocks with the highest dividend yields in the S&P 500 gives us an interesting candidate, a real estate investment trust, namely Vici Properties. The Vici trade doesn’t pay its next dividend, of 43 cents per share, until March, but if you want to collect your dividend before then, you might consider selling cash-secured puts. The February 27.5 put is 4.5% out of the money and yields about 43 cents, or about 1.5% over the next two months. If the stock falls due to that strike, one could buy Vici at a discount of about 6% to the current share price. If not, one would effectively receive an option premium equal to the amount of the predicted dividend. Disclosure: (None) All opinions expressed by CNBC Pro contributors are theirs alone and do not reflect the opinions of CNBC, NBC UNIVERSAL, its parent company or affiliates, and may have been previously published by them on television, radio, the Internet or spread on other media. The above is subject to our Terms and Conditions and Privacy Policy. This content is for informational purposes only and does not constitute financial, investment, tax or legal advice or a recommendation to purchase any security or other financial asset. The content is general in nature and does not reflect any individual’s unique personal circumstances. 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Strategies of choice to generate income for the “dog of the S&P 500” | Real Time Headlines
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