By MARK HULBERT
Picking high-dividend stocks is not as simple or straightforward as it initially appears.
You might think that you should just pick the stocks with the highest yields. Surprisingly, that turns out to be an inferior approach.
Take the so-called Dogs of the Dow strategy, which is perhaps the best-known approach among the retail investment public for picking high-yield stocks. The strategy took the investment world by storm in the early and mid-1990s, on the strength of both its simplicity and excellent long-term track record -- at least when backtested.
A funny thing happened on the way to the bank, however: In real time since then, the strategy has failed to keep up with a simple index fund. For example, the strategy has beaten the Dow itself in just 5 of the last 16 calendar years. And those five winning years have not made up for the losses incurred in the 11 losing years.
The handful of advisory services tracked by the HFD that were devoted to the Dogs of the Dow either went out of business or changed their focus.
By the way, I am not aware of any variants of this strategy that have an appreciably better record. One of the more popular of these variants is the one that calls for investing in the five lowest-price stocks among the 10 highest-yielding of the Dow 30.
One of the investment newsletters monitored by the Hulbert Financial Digest maintains a model portfolio that follows this five-stock strategy: Mark Skousen's Forecasts & Strategies. Since the beginning of 1997, which is when the HFD began monitoring this letter's so-called "Flying Five Portfolio," it has lagged a buy-and-hold strategy by two percentage points per year on an annualized basis, according to the HFD.
Why did this simple approach to picking high-dividend stocks fail to beat a buy-and-hold? One clue comes from the far more successful approach utilized by another advisory service that the HFD tracks: Investment Quality Trends, edited by Kelley Wright.
Wright's approach calls for comparing a stock's current dividend yield to its past yield -- relative yield, if you will. He considers the stock to be undervalued only if it is trading at or close to the highest it has ever yielded in the past.
To illustrate the differences between his approach and a focus on absolute yield, consider General Electric (GE)
Over the last 16 years, during which the Dogs of the Dow strategy has lagged a buy-and-hold, Investment Quality Trends has beaten the market by nearly two percentage points per year on an annualized basis. And, better yet from a risk-adjusted point of view, it produced this market-beating return with below-market risk.
Of the 10 current Dogs of the Dow, Wright places just four in his "undervalued" category:
Johnson & Johnson (JNJ),