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Jubak's Journal
Recent articles:
• Welcome to the bankruptcy economy, 9/21/2004
• Often-bearish October could be one for the bulls, 9/17/2004
• 5 stocks truckin' ahead, 9/15/2004
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New tricks for Dogs of the Dow
Value investors have followed the Dogs of the Dow strategy to success since 1928. But its popularity can be a liability. Heres a Dog Stars screen for sniffing out rewards in the next stock trend.
By Jim Jubak
(Authors note: This is the second of a three-part series on seasonal trends in the stock market. The first part, Often-bearish October could be one for the bulls, was published Sept. 17. The final installment will appear Sept. 28.)
Autumn arrived only two short days ago, but its time to start thinking about the next big seasonal stock-market effect and about buying the Dogs of December. Thinking this far ahead can be profitable: Over the last 30 years, one Dogs of December strategy has gained an average 13% in just six to eight weeks in January and February.
Youve probably heard of the Dogs of the Dow strategy, the most famous example of a buy-them-when-theyre-hated approach. The strategy works like this: Every Dec. 31, you buy the highest-dividend-yielding stocks in the Dow Jones Industrial Average ($INDU). Because a stocks dividend yield goes up as the price of a share falls, this is a simple way to buy shares of the 10 most-battered stocks in the index. You then hold the shares for a year and rebalance the portfolio by selling these stocks and buying a new group of losers next December.
This extraordinarily simple strategy has yielded market-beating returns decade after decade. From 1928 to the present, the Dogs of the Dow strategy returned an average annual compounded rate of 13%. That was almost 2 percentage points a year better than the return on the Dow industrials and 2.5 percentage points better than the return on the Standard & Poors 500 ($INX). (Ive updated the results reported by Jeremy Siegel in his book Stocks for the Long Run.)
2 secrets to Dogs success
The 1930s and the 1990s were the only two decades in which the Dogs of the Dow strategy didnt outperform the Dow Jones Industrial Average and the S&P 500 Index. The approach lagged the S&P 500 in the 1990s, Siegel notes, because 1999, the last year before the bubble burst, was the worst year ever for the strategy. It turned in a positive performance that year but lagged the S&P 500 by more than 18 percentage points.
The Dogs of the Dow strategy turns in its best monthly performance in January. Thats led Yale and Jeffrey Hirsch to propose an improved approach, called the Free Lunch strategy. As laid out in the "Stock Traders Almanac," their strategy calls for buying all the New York Stock Exchange stocks selling at their lows in mid-December and holding them to Feb. 15. The average gain on the strategy since 1974 comes to about 13% in six weeks. That compares to the average 5% gain in the NYSE Composite ($NYA.X) for the period.
I think there are two reasons these two strategies work.- First, already beaten-down stocks decline even further as investors sell their losers to lock in tax losses for the year. When the selling pressure is relieved in January and February, these stocks bounce back from deeply depressed to simply depressed levels.
- Second, the 30 stocks that make up the Dow Jones Industrial Average tend to be long-term survivors. These companies have enough financial strength to weather short-term troubles without going out of business. They survive bad times long enough to see the return of better times. Boeing (BA, news, msgs), up almost 30% in 2004, is an example of the benefits of being financially strong enough to survive the worst of times.
Introducing the Dog Stars
This leads me to propose my own approach -- I call it the Dog Stars strategy -- that attempts to improve on both the Dogs of the Dow and the Free Lunch strategies.
The Dogs of the Dow has become increasingly popular in recent years, and returns have fallen as more and more investors adopt the same approach. One way to get around this is to expand the universe of dogs beyond the Dow. But I dont want to just switch to another universe at random. One of the weaknesses in the Free Lunch strategy, in my mind, is that while it expands the universe from the 30 Dow stocks to all of the NYSE, it gives up the screening for financial strength that picking from the Dow provides.
In my Dog Stars strategy, Im still going to look for new lows on Dec. 15. But Im going to expand my universe to all stocks, and to replace the financial screen provided by membership in the Dow Jones industrials, Im going to use the Stock Screener to screen for financial strength as well as low price.
My screen parameters are:- Market capitalization of $1 billion or more.
- Debt-to-equity ratio of 1 or less.
- Quick ratio of 1 or more. (The quick ratio divides liquid assets by current liabilities. The higher the quick ratio, the more a company is able to meet current liabilities from liquid assets on hand even if revenue dries up.)
- New 52-week low in the last quarter.
- Current price within 20% of that 52-week low.
This list identifies stocks I might want to buy for a Dog Stars strategy at the end of December. To identify my final list, around Dec. 15, Id want to re-run the screen after tightening that last requirement to find stocks that are closer than 20% to their 52-week low. Look for an update column on this strategy and screen shortly after mid-December.
10 Dog Stars to watch
As of Sept. 20, 85 stocks pass my screen. (Please remember this is a very fluid universe.) You can run the screen yourself here.
Ive picked 10 from the list worth watching:- Technology: Nokia (NOK, news, msgs) and Western Digital (WDC, news, msgs).
- Drugs: Teva Pharmaceutical Industries (TEVA, news, msgs) and Merck (MRK, news, msgs).
- Media: Westwood One (WON, news, msgs) and Interpublic Group (IPG, news, msgs).
- Financial: Charles Schwab (SCH, news, msgs) and MBNA (KRB, news, msgs).
- Consumer: Reynolds & Reynolds (REY, news, msgs) and Hasbro (HAS, news, msgs).
Why these 10? I combed the 85 companies looking for plausible recovery stories that could make a stock stand out for bargain hunters. Nokia, for example, is introducing a raft of new models that could help it regain market share and restore some of its profit margin. Is that story strong enough to make the stock a sure thing or to put it on the buy list of a growth investor? I dont think so. In fact, I think the odds are this story wont play out for Nokia until 2006. But the existence of a recovery story is essential to put a stock on a value investors screen. And value investors are accustomed to weighing the odds a recovery story will prove to be accurate against the price of shares. At some point Nokia is cheap enough so that even a recovery story with relatively low odds becomes a reasonable value buy. And thats what I think Ive found in each one of these 10.
Now lets see if they get cheap enough by mid-December to qualify as Dog Stars.
New developments on past columns
Often-bearish October could be one for the bulls
The financial markets got just about what they expected and then some from the Federal Reserve on Sept. 21. The Feds Open Market Committee raised short-term interest rates another 25 basis points to 1.75 (100 basis points equal one percentage point). That was exactly what the markets had been expecting. The then some came in the Feds press release, where Alan Greenspan & Co. opined that growth seems to have regained some traction, Fed-speak for growth seems to be picking up after the summer slump. The central bank also promised that with inflation subdued -- inflation expectations have eased were the exact words -- future rate increases would continue to be measured, Fed-speak for gradual. Before the announced rate hike, the fed funds futures market, where the price of futures fluctuates with traders expectations for future interest rates, had priced in a 98% chance for a September increase of 25 basis points. The market was also pricing in a 71% chance for another quarter-point increase in November, but put the chance for a December hike, which would be the fifth since June, at just 22%. The market was still expecting interest rates to go up again in 2005, with the futures pricing in a 69% chance of an interest-rate increase at the Feds February meeting.
Welcome to the bankruptcy economy
In my Sept. 21 column on the bankruptcy economy, I pointed out that demographics had put General Motors (GM, news, msgs) in quite a hole: 200,000 active workers support 450,000 retirees. But the recent announcement that Lucent Technologies (LU, news, msgs) will cut retiree health-care benefits again points out that downsizing can turn already unfavorable demographic trends into a truly nasty squeeze. Before its recent rounds of downsizing, Lucent Technologies employed 157,000 people in 2000. The current workforce is just 32,300. But because at least some of that reduction resulted from workers taking early retirement, the number of retirees has climbed to 125,000, up 18% from the end of 2000. You do the math. In 2000 the company had 157,000 active workers and 106,000 retirees. In 2004, Lucent has 32,300 active workers and 125,000 retirees. After the most recent health care-benefit cuts, the second this year, the dependents (including spouses) of workers who retired after March 1, 1990, with a salary of $65,000 or more, will no longer be covered. The cuts take effect in January and are expected to save the company $16 million.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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