Beat the Dow !

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DOGS OF THE DOW

The investing strategy which focuses on Dogs of the Dow was popularized by Michael Higgins in his book, "Beating the Dow". The strategy's simplicity is one of its most attractive attributes. The Dogs of the Dow are the 10 of the 30 companies in the Dow Jones Industrial Average(DJIA) with the highest dividend yield. In the Dogs of the Dow strategy, the investor shuffles around his or her portfolio, adjusting it so that it is always equally allocated in each of these 10 stocks.

Typically, such an investor would need to completely rid his or her portfolio of about three to four stocks every year and replace them with different ones. The stocks are usually replaced because their dividend yields have fallen out of the top 10, or occasionally, because they have been removed from the DJIA altogether.

Is it really that Simple?
Yes, this strategy really is as simple as it sounds. At the end of every year, you reassess the 30 components of the DJIA, determine which ones have the highest dividend yield, and ask your broker to make your portfolio as equally weighted in each of these 10 stocks as possible. Hold onto these 10 stocks for one calendar year, until the following Jan 1, and repeat the process. This is a long term strategy, requiring a long period to see results. There have been a few years in which the Dow has outperformed the Dogs, so it is the long-term averages that proponents of the strategy rely on.

The Premise
The premise of this investment style is that the Dow laggards, which are temporarily out-of-favor stocks, are still good companies because they are still included in the DJIA; therefore, holding on to them is a smart idea, in theory. Once these companies rebound and the market has revalued them properly (or so you hope), you can sell them and replenish your portfolio with other good companies that are temporarily out of favor. Companies in the Dow have historically been very stable companies that can weather any market decline with their solid balance sheets strong fundamentals. Furthermore, because there is a committee perpetually tinkering with the DJIA's components, you can rest assured that the DJIA is made up of good, solid companies.

By the Numbers
As mentioned earlier, one of the big attractions of the Dogs of the Dow strategy is its simplicity; the other is its performance. From 1957 to 2003, the Dogs outperformed the Dow by about 3%, averaging a return rate of 14.3% annually whereas the Dows averaged 11%. The performance between 1973 and 1996 was even more impressive, as the Dogs returned 20.3% annually, whereas the Dows averaged 15.8%.

Variations of the Dogs
Because of this strategy's simplicity and its returns, many have tried to alter it in an attempt to refine it, making it both simpler and higher yielding. There is the Dow 5, which includes the five Dogs of the Dow that have the lowest per share price. Then there is the Dow 4, which includes the 4 highest priced stocks of the Dow 5. Finally, there is the Foolish 4, made famous by the Motley Fool, which chooses the same stocks as the Dow 4, but allocates 40% of the portfolio to the lowest priced of these four stocks and 20% to the other three stocks.

These variations of the Dogs of the Dow were all developed using back testing, or testing strategies on old data. The likelihood of these strategies outperforming the Dogs of the Dow or the DJIA in the future is very uncertain; however, the results of the back testing are interesting.

Before you go out and start applying one of these strategies, consider this: picking the highest yielding stocks makes some intuitive sense, but picking stocks based strictly on price seems odd. Share price is a fairly relative thing; a company could splits shares but still is worth the same, simply having twice as many shares with half the share price. When it comes to the variations on the Dogs of the Dow, there are many more questions than there are answers.

Dogs Not Fool Proof
As is the case with the other strategies we've looked at, the Dogs of the Dow strategy is not fool-proof. The theory puts a lot of faith in the assumption that the time period from the mid-20th century to the turn of the 21st century will repeat itself over the long run. If this assumption is accurate, the Dogs will provide about a 3% greater return than the Dow, but this is by no means guaranteed.

Conclusion
The Dogs of the Dow is a simple and effective strategy based on the results of the last 50 years. Pick the 10 highest yielding stocks of the 30 Dow stocks, and weigh your portfolio equally among them, adjusting the portfolio annually, and you can expect about a 3% out performance of the Dow. That is, if history repeats itself.

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Efficient market hypothesis

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There are three common forms in which the efficient market hypothesis is commonly stated — weak form efficiency, semi-strong form efficiency and strong form efficiency, each of which have different implications for how markets work.

Weak-form efficiency

• No excess returns can be earned by using investment strategies based on historical share prices.
• Weak-form efficiency implies that Techinical analysis techniques will not be able to consistently produce excess returns, though some forms of fundamental analysis may still provide excess returns.
• In a weak-form efficient market current share prices are the best, unbiased, estimate of the value of the security. Theoretical in nature, weak form efficiency advocates assert that fundamental analysis can be used to identify stocks that are undervalued and overvalued. Therefore, keen investors looking for profitable companies can earn profits by researching financial statements.

Semi-strong form efficiency

• Share prices adjust within an arbitrarily small but finite amount of time and in an unbiased fashion to publicly available new information, so that no excess returns can be earned by trading on that information.
• Semi-strong form efficiency implies that Fundamental analysis techniques will not be able to reliably produce excess returns.
• To test for semi-strong form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. If there are any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient manner.

Strong-form efficiency

• Share prices reflect all information and no one can earn excess returns.
• If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored. Studies on the U.S. stock market have shown that people do trade on inside information.
  
• To test for strong form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. Even if some money managers are consistently observed to beat the market, no refutation even of strong-form efficiency follows: with tens of thousands of fund managers worldwide^], even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers.

'Investments' is a sacred term for individuals. For many, investing means a kind of 'compulsory' savings from one's earnings and getting lumpsum money later.

However, there is a lot more to investing than just that. Investing falls within a broader gamut of financial planning. It requires considerable thought and groundwork. Here, we have outlined some important guidelines to be borne in mind while planning your finances.

1. Do your homework

Before investing your money, ensure that you have done your homework well. It is 'normal' for sales pitches to be aggressive. Most sales executives are mainly interested in 'commission earned' or 'business garnered', which reflects in their monthly targets. That is why one only gets to hear the 'best case scenario' from agents/sales executives.

A lot of sales agents/consultants try to exploit the individual's vulnerability and lack of knowledge while making a sales pitch. For instance, how else can you explain so many individuals in the low-risk category investing in high-risk ULIPs?

Or why term plans, in spite of being the cheapest form of insurance, are still not bought by most individuals? Or why mutual fund IPOs find so much favour with investors even when there is no fit in their portfolios?

One should understand his own profile in terms of income, risk appetite and future plans and only then, make investments in tune with the same. Individuals need to know what benefits different products offer and how they fit into their financial portfolios before taking a call on investing in them.

You must listen to advice from different quarters but the final decision should rest with you alone after a careful analysis. After all, it's your own hard-earned money.

2. Keep your eyes and ears open

Keep your eyes and ears open at all times for any investment opportunity that comes your way. The opportunity could be by way of changing market scenario or new product launches. Individuals shouldn't lose out on any opportunity just because they didn't know it existed.

Of course, this involves a bit of updating yourself with latest product trends, market conditions and changing economic scenario. This way, you will not be completely at the mercy of the consultant/agent to provide you with investment-related information and solutions.

3. Involve yourself

While buying any financial product, ensure that you have involved yourself at critical stages. For example, while taking life insurance, see to it that you personally fill all the details in the proposal form. I

nsurance agents many a times, used to, themselves, fill up details like the height and weight of the insured, his age and medical history among other things, based solely on their own judgement. They merely asked the individual to sign on the form at the end.

What individuals don't realise is that this can lead to rejection of claims at a later stage if discrepancies are found in the proposal form. The insurance company cannot be faulted for rejecting such a claim. It is a shortcoming on the agent's part who should have requested you to fill the form yourself, else fill it himself after verifying your details.

All the necessary medical tests should also be diligently given. As mentioned earlier, any 'false claims' might lead to rejections at a later date.

4. Inform your near and dear ones

This is especially true in case of life insurance. Inform your near and dear ones as soon as the policy is bought. If your spouse and/or parents know that you have a life insurance cover wherein he/they are nominees, they will be better placed to follow up with the life insurance company for the claim proceeds should something happen to you.

Typically, life insurance should not be so sacred that you don't broach the topic in the family. All related (and affected) parties must know exactly what needs to be done in your absence.

5. Maintain a logbook

Always maintain a logbook of your life insurance policies/investments. Individuals can and do have a variety of investments ranging from life insurance (endowment, term plan, ULIPs) to mutual funds and PPF/NSCs. A logbook should contain details about the same.

Over an extended period of time, it becomes difficult for one to remember or track investment details like maturity date, maturity value and rate of interest. This logbook will take care of that problem. Of course, it goes without saying that for the logbook to be really effective and useful, it should be updated periodically to reflect investments and redemptions.

This logbook should also include details of an individual's liabilities like home loans, personal loans, the amount outstanding on such loans, the EMI and business liabilities (in case the individual runs a business) among others.

Details of the logbook should also be shared with your dependents (spouse, children, parents). An important reason for making a copy is, in case of an unfortunate eventuality, the spouse knows his/her exact financial status. Also, one wouldn't want someone to come out of nowhere one fine day and stake a claim on the family's assets based on some 'fictitious' liability.

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Dow theory

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in this post we will see what is the dow theory

The dow theory has the following six tenets

1. Markets have three trends

Dow defined an uptrend (trend 1) as a time when successive rallies in a security price close at levels higher than those achieved in previous rallies and when lows occur at levels higher than previous lows. Downtrends (trend 2) occur when markets make lower lows and lower highs. It is this concept of Dow Theory that provides the basis of technical analysis' definition of a price trend. Dow described what he saw as a recurring theme in the market: that prices would move sharply in one direction, recede briefly in the opposite direction, and then continue in their original direction (trend 3).

2. Trends have three phases

Dow Theory asserts that major market trends are composed of three phases: an accumulation phase, a public participation phase, and a distribution phase. The accumulation phase (phase 1) is when investors "in the know" are actively buying (selling) stock against the general opinion of the market. During this phase, the stock price does not change much because these investors are in the minority absorbing (releasing) stock that the market at large is supplying (demanding). Eventually, the market catches on to these astute investors and a rapid price change occurs (phase 2). This is when trend followers and other technically oriented investors participate. This phase continues until rampant speculation occurs. At this point, the astute investors begin to distribute their holdings to the market (phase 3).

3. The stock market discounts all news

Stock prices quickly incorporate new information as soon as it becomes available. Once news is released, stock prices will change to reflect this new information. On this point, Dow Theory agrees with one of the premises of the efficient market hypothesis.

4. Stock market averages must confirm each other

In Dow's time, the US was a growing industrial power. The US had population centers but factories were scattered throughout the country. Factories had to ship their goods to market, usually by rail. Dow's first stock averages were an index of industrial (manufacturing) companies and rail companies. To Dow, a bull market in industrials could not occur unless the railway average rallied as well, usually first. According to this logic, if manufacturers' profits are rising, it follows that they are producing more. If they produce more, then they have to ship more goods to consumers. Hence, if an investor is looking for signs of health in manufacturers, he or she should look at the performance of the companies that ship the output of them to market, the railroads. The two averages should be moving in the same direction. When the performance of the averages diverge, it is a warning that change is in the air.
Both Barron's Magazine and the Wall Street Journal still publish the daily performance of the Dow Jones Transportation Index in chart form. The index contains major railroads, shipping companies, and air freight carriers in the US.

5. Trends are confirmed by volume

Dow believed that volume confirmed price trends. When prices move on low volume, there could be many different explanations why. An overly aggressive seller could be present for example. But when price movements are accompanied by high volume, Dow believed this represented the "true" market view. If many participants are active in a particular security, and the price moves significantly in one direction, Dow maintained that this was the direction in which the market anticipated continued movement. To him, it was a signal that a trend is developing.

6. Trends exist until definitive signals prove that they have ended

Dow believed that trends existed despite "market noise". Markets might temporarily move in the direction opposite the trend, but they will soon resume the prior move. The trend should be given the benefit of the doubt during these reversals. Determining whether a reversal is the start of a new trend or a temporary movement in the current trend is not easy. Dow Theorists often disagree in this determination. Technical analysis tools attempt to clarify this but they can be interpreted differently by different investors.


dow theory is one of the strategies of share trading
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