The Dogs of the Dow Are Ending 2021 With a Whimper. Why Next Year Could Be Better.

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Pedestrians passing a Verizon store in San Francisco. Verizon is one of the highest-yielding stocks in the Dow Jones Industrial Average.

David Paul Morris/Bloomberg

The Dogs are in the doghouse again this year.

The Dogs of the Dow, the 10-highest yielding stocks in the Dow Jones Industrial Average, have returned 9% this year (including dividends) based on prices last Friday, almost 10 percentage points behind the index’s 18.3% total return and far back of the S&P 500’s 26.7% return.  

While 2021 isn’t over yet, the Dogs are on track to trail the Dow Industrials for the fifth year in a row.

The Dogs are an income and contrarian investment strategy that has been popular with individuals for decades. Most practitioners rebalance their portfolios annually at the end of the year.

The idea is that buying the Dogs each year allows investors to rotate into financially strong, high-dividend stocks that are out of favor on Wall Street. But like many value-oriented strategies in recent years, the Dogs have lagged behind.

The coming year could be better for the Dogs. The portfolio of 10 likely Dogs yields an average of 4%, against just 1.7% for the index and 1.3% for the S&P 500. The dividends on all 10 look pretty secure. The Dogs offer an alternative to low-yielding bonds with double the yield of the 30-year Treasury bond.

The strategy this year has been hurt by declines in two Dogs, Amgen (ticker AMGN) and Verizon Communications (VZ). There have been few big winners among the other eight stocks: IBM (IBM), Chevron (CVX), Dow (DOW), Walgreens Boots Alliance (WBA), 3M (MMM), Cisco Systems (CSCO), Merck (MRK) and Coca-Cola (KO). Chevron is the only one with standout returns this year.

In the Doghouse

Here’s how the Dogs of the Dow, the 10-highest yielding stocks in the Dow Jones Industrial Average, have performed so far this year.

Company / Ticker Recent Price YTD Return (includes dividends) Dividend Yield
IBM / IBM $116.05 1.4% 5.7%
Verizon Communications / VZ 50.86 -9.5 5.0
Dow / DOW 57.34 6.7 4.9
Chevron / CVX 111.91 39.5 4.8
Walgreen Boots Alliance / WBA 46.98 22.3 4.1
Amgen / AMGN 206.08 -7.6 3.4
3M / MMM 179.23 5.8 3.3
Merck / MRK 80.70 6.2 3.2
Coca-Cola / KO 55.13 2.9 3.0
Cisco Systems / CSCO 53.25 22.5 2.8
Dow Dogs Average 9.0% 4.0%
Dow Jones Industrial Average 18.3 1.7

Source: Bloomberg

Nine of the 10 will likely be back in 2022 based on current yields. Cisco Systems is on course to drop out in favor of Intel (INTC) as the semiconductor maker now has the 10th-highest yield in the Dow Industrials at 2.8%.

The yield gap between Intel and Cisco, however, is less than a 10th of a point after Cisco’s recent stock drop on disappointing earnings, meaning 2022 could have the same 10 stocks as this year. The 12th-highest yielding stock is now Johnson & Johnson (JNJ) at 2.6%.

One factor working in favor of the likely 2022 Dogs is valuation. Seven of the 10 stocks have price-to-earnings ratios of 12 or lower based on projected 2022 earnings—against a multiple of about 21 for the S&P 500.

One of the knocks against the Dogs is that they have become a relatively static portfolio of old-economy stocks. The Dow components with the strongest growth prospects yield less than 2% — stocks like Microsoft (MSFT), Apple (AAPL), and Home Depot (HD) — and they are not likely to fall into the Dog camp barring a sharp drop in their stock prices.

 Over more than a decade, the Dogs strategy has trailed the overall index. A $10,000 investment in the Dogs at the end of 2009 would have grown to about $40,000, against $46,000 for the index, Barron’s calculates.

Leading this year’s winners within the Dogs is Chevron, which has returned about 39%, driven by a profit rebound and heightened investor confidence in the security of its dividend. At around $112, the stock isn’t expensive trading for about 12 times next year’s projected earnings and yielding 4.8%.

Morgan Stanley analyst Devin McDermott is bullish on Chevron, citing its 12% projected free-cash flow yield for 2022 and potentially more aggressive stock buybacks.

Walgreen, up about 22% this year including dividends, has been bolstered by 15% growth in adjusted earnings per share in its fiscal year ending in August and a low valuation. Even after its move, Walgreen, at a recent $47, trades for only nine times next fiscal year’s projected earnings and yields 4.1%

IBM is projecting mid-single digit sales growth in the coming years following the recent spinoff of slow-growth Kyndryl Holdings (KD), a technology infrastructure manager. That prospect could entice investors after years of organic revenue declines. IBM, at around $116, has the index’s highest yield at 5.7% and trades for just 11 times projected 2022 earnings.

Merck has been held back by concerns about its reliance on Keytruda, the leading drug that harnesses the immune system to fight lung and other cancers. The company’s Covid-19 vaccine was a bust, and its new Covid treatment may be trumped by a more effective drug from rival Pfizer (PFE). But at around $81, Merck is inexpensive trading for about 11 times projected 2022 earnings and yielding 3.2%.  

Al Root contributed reporting to this article.

Write to Andrew Bary at andrew.bary@barrons.com