The new product, the Sector Dividend Dog ETF (SDOG) offers exposure to the highest yielding 50 stocks by applying the well-known “Dogs of the Dow” methodology from a wider set of stocks instead of the S&P 500.
SDOG selects stocks across all the 10 sectors of the market and picks five highest yielding stocks from each sector, ensuring diversification at both the stock and sector level. The “Dogs of the Dow” strategy, made famous by Michael O’Higgins in 1991, is based on the premise that blue-chip companies don’t adjust dividends to reflect current trading prices, and therefore while stock prices fluctuate through business cycles, dividends in contrast, is an indicator of average worth of the company.
This means companies trading at a high-dividend yield ratio are at the bottom of their business cycles and hence are likely to appreciate faster than low yield stocks when the business cycle changes.
However, several assumptions are made in this theory; first, dividends paid reflects the company size rather than the model and second, companies have natural repeating cycles where bad cycles are followed by good ones. A high dividend yield indicates the stock is oversold and the management is backing up its faith in the firm through higher dividend payouts.
The fund tracks the S-Network Sector Dividend Dogs Index (SDOGX), the benchmark in which investors select annually the top ten DJIA stocks with the highest yield from each sector at the start of the year.
Since every stock has equal weighting, each stock contributes about 2 percent to the total weight (five stocks from each of the 10 sectors) while each sector contributes about 10 percent. The index has returned about five percent as of June 15, 2012 while the S&P 500 returned 2.04 percent in the same period. For the 20-year period between 1992 and 2011 that includes many booms and busts, the SDOGX index outperformed the S&P 500 (9.6%) while matching the returns of DJIA (10.8%).
Sector allocations include Telecommunication Services (10.3%), Financials (10.1%), Consumer Staples (10%), Industrials (10%), Healthcare (10%), Energy (10%), Information Technology (9.9%), Consumer Discretionary (9.9%), Materials (9.9%) and Utilities (9.9%). The fund charges 40 basis points annually while the expense ratio for dividend ETFs vary between 0.13% and 0.88%.
It’s an interesting concept, and I will revisit this idea again as time has passed and more data points have become available.
Disclosure: No holdings