The Daily Dow
Tuesday, June 17, 1997
by Randy Befumo (TMF Templr)
WILLIAMSBURG, VA. (June 17, 1997) -- Why does the Dow Approach work? Over the past few days, I have argued that quantity, quality and holding period explain a large part of it. Today, I will argue that the subtlest part of the whole equation, the dividend yield, provides the lion's share of the excess returns.
For years investors have divided themselves into growth, value, and income camps. The growth guys don't care about the dividends. In fact, they see them as a sign of corporate decrepitude and weakness, coddling shareholders. Value fellows don't mind 'em, but they can live without 'em. Income investors thrive off them, but tend to chase the high dividends that accompany no-growth industries like utilities, industries that apparently have forgotten the best way to get the stock price up is to get earnings up. Growing companies that pay above average, but not exceptional, dividends tend to get lost in the shuffle.
Well, folks, all other things being equal, a basket of stocks with an above average yield will outperform a basket of stocks with an average or below average yield. If you have thirty or so companies of roughly the same size, quality, and caliber and plan to hold them for the same time period, the ones that have higher yields will outperform the rest of the lot, more often than not. The Dow Approach forces investors to become total return junkies, squeezing an extra percent or two out of their annual returns that compounds into real wealth over the long haul.
A mere 1% difference compounded over twenty years means 22% greater total returns. If you were only going to earn 1000% over twenty years, getting another 1% means you will earn 1220%. And so it goes. Each incremental percent gain you squeeze out per year means a tremendous amount of money after many years. Investors in the Dow Approach are forced to pay attention to this understated fact that most other investors forget, just like they are forced to consider tax efficiency, minimize transaction costs, buy quality companies unlikely to be hurt by one bad decision, and buy large companies that, in the end, investors almost always have to return to.
O'HIGGINS & CYCLICALS
We postpone "DOW NEWS" today because I have gotten loads of mail on my comment a few days ago about Michael O'Higgins and the fact that he was bearish on the Dow Approach because the Dow kept taking out all of the cyclical companies. I want to clarify my source and then share some thoughts about Mr. O'Higgins and why I believe his hypothesis for why the Dow Approach works is completely incorrect.
When the most recent change in the Dow as made, Rogue correspondent Louis Corrigan interviewed Mr. O'Higgins in an article called "A Brand-New Dow?" It was there that O'Higgins stated:
"I think [the changes] will make a great deal of difference because the components that are being replaced are generally of a more cyclical nature. And I think it will hurt the ability of this program to work because you're getting much more homogeneity in the Dow in terms of all kinds of well-capitalized, 'growthie' type companies and away from the historical, cyclical bent of the Dow, which has been diminishing in recent years. This is putting another major dent in the cyclicality of the Dow components."
As a result, he thinks the Dogs of the Dow strategy will be hurt. "The major ingredient in this approach is that you have companies that are very susceptible to the business cycle, kind of basic industrial companies. So these are the ones that tend to get in trouble in bad times. They also tend to be more leveraged. So they either do very well or very poorly. Their fortunes vary a great deal."
At the same time, O'Higgins added:
"Anybody who knows financial history has to be bearish," O'Higgins said. "Only those people, perhaps like yourself or the Gardner brothers, who haven't been around long enough to have been through some market cycles and haven't studied financial history, or honestly believe this malarkey that this is truly a new era" could be anything but bearish.
Apparently O'Higgins does not believe that individuals like Abby Joseph Cohen,
chief investment strategist at Goldman Sachs, have studied history very well.
Regardless of his rather negative assessment of anyone who might happen to
believe that with low inflation and moderate growth the S&P tends to
be priced in the 18 to 20 times earnings range (as it was in the '50s and
early '60s), I think O'Higgins has missed the point by looking at the cyclicals
-- the very point I have tried to make over the last four Dow installments.
I would advise investors not to worry too much about what O'Higgins has to
say on valuation or how the market works. Since O'Higgins made his comments,
the Dow has risen 14%. In fact, the man has been decidedly negative since
1995, leaving his clients in bonds yielding some of the lowest rates in the
past three decades.
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. ________________________________
Stock Change Last -------------------- T - 3/8 37.88 GM - 1/2 57.00 CHV - 3/4 76.13 MMM +2 1/4 100.00
Day Month Year
FOOL-4 -0.22% 4.75% 5.20%
DJIA -0.15% 5.86% 20.35%
S&P 500 +0.06% 5.44% 20.75%
NASDAQ +0.78% 3.06% 11.78%
Rec'd # Security In At Now Change
1/2/97 120 3M 83.00 100.00 20.48%
1/2/97 153 Chevron 65.00 76.13 17.12%
1/2/97 179 Gen. Motor 55.75 57.00 2.24%
1/2/97 479 AT&T 41.75 37.88 -9.28%
Rec'd # Security In At Value Change
1/2/97 120 3M 9960.00 12000.00 $2040.00
1/2/97 153 Chevron 9945.00 11647.13 $1702.13
1/2/97 179 Gen. Motor 9979.25 10203.00 $223.75
1/2/97 479 AT&T 19998.25 18142.13 -$1856.13
CASH $609.53
TOTAL $52601.78