Dogs of the Footsie: how our investment strategy has beaten the FTSE 100 again

Although it was a difficult year for shares, Money Observer’s Dogs strategy again proved to be a winning formula. David Budworth reports on how the 10 high-yielding blue-chips ran.

The past 12 months have been tough for investors, as Trump’s trade war, US interest rates, Brexit and the slowdown in China have buffeted global stockmarkets. Against such an unstable backdrop, it is no surprise that over the past year most of our Dogs of the Footsie high-yielding shares failed to sparkle significantly – GlaxoSmithKline being a notable exception.

Yet, even without the dazzle, the Dogs strategy once again proved its worth. Money Observer has been compiling the Dogs of the Footsie portfolio since 2001, and it has been one of the most successful investment approaches, beating the FTSE 100 index over three, five and 10 years, and since portfolio inception. Last year, it outperformed the FTSE 100 index again, beating the benchmark in 13 of the past 18 years.

However, let’s not be too cocky, as last year’s returns were disappointing. Overall, the portfolio lost 4.4% based on share price performance alone, though this was ahead of the 6.3% loss suffered by the index. On a total return basis taking account of dividend payments, the Dogs scraped into positive territory with a 2.2% return, compared with a negative 2.3% for the index. So it could have been worse, but it was hardly a pedigree year.

A table showing the Dogs v FTSE 100 performance over 18 years

Please click here to enlarge table

How does the strategy work?

For those readers new to the Dogs strategy, it first became popular in the US in the 1990s after Michael B Higgins wrote his book Beating the Dow, and we have simply adapted it for the UK. The strategy involves simply putting an equal amount into the 10 FTSE 100 companies with the highest dividend yields, and holding them for a year.

The beauty of the approach is that it requires hardly any time or resources. The 10 companies with the highest historic yield – based on past dividend payments – can be easily obtained using a screening tool on websites such as SharePad (sharepad.co.uk). Once you have set a Dogs portfolio running, it requires no further attention for the next 12 months – at which point the process can be repeated.

The logic behind the strategy is that a high dividend yield tends to indicate that a company is unloved, either because it has been through a bad patch or because it is in a sector that is out of favour. In such situations, the shares can often fall well below their fair value. Over time, the theory goes, they should catch up with the broader market and in the process outperform the index. In the meantime, patient investors will be rewarded with generous dividends underpinning the high yield.

While a portfolio of 10 companies might sound small, it can still offer decent diversification. Over the past year, seven of the companies in the portfolio did better than the index in total return terms, and six in price terms, compensating for the laggards.

GlaxoSmithKline was the stock to beat, producing an impressive total return of 19%. BP, Centrica and National Grid also achieved double figures when dividends are included. By contrast, BT, Imperial Brands and SSE all finished the year in negative territory.

A table showing the 2018 returns of the Dogs portfolio

 

Dividend threat

The worst performer by far was Vodafone, which fell 35% in share price terms. The main cause of the sell-off of the telecom giant’s shares has been the market’s expectation that the company’s two-decade dividend growth streak is about to end.

Vodafone’s struggles highlight the most obvious risk of the Dogs strategy, namely, that a high yield signals that a company is in trouble and a dividend cut is on the cards. However, one of the rules when selecting the Dogs is that companies are not excluded on the basis of forecasts or rumours alone. Only companies that have officially announced a dividend cut should be excluded.

If companies were ruled out on the basis of hearsay about dividend cuts, almost all our Dogs would have been chopped. Centrica, Royal Dutch Shell and the portfolio’s star performer GlaxoSmithKline have all been accused of paying dividends they cannot afford in terms of dividend cover, which measures how comfortably companies can meet their dividend promises.

To offer a margin of safety to dividend payments, ideally dividend cover needs to be around the 2.0 level (meaning the company’s dividend is covered twice by its earnings). All last year’s Dogs fall short of this. That’s far from ideal, though cutting dividends is often a last resort for companies after other options to shore up their balance sheets have been dismissed or failed.

Once a company has a track record of paying reliable dividends, management will often move heaven and earth to avoid disappointing investors by cutting the payout. So have any of our Dogs slashed their dividends over the past year? Only BT, which lowered its interim dividend as cash flows plunged. However, SSE has already signalled a dividend cut in 2019/20, disqualifying itself from inclusion in our Dogs portfolio for the next 12 months.

Longer-term focus

So what is in store for our kennel line-up for 2019? The past year has been a difficult one for both our Dogs and stockmarkets more generally. The next 12 months may not be any easier, given that global growth has slowed and geopolitical concerns such as the China-US trade war and Brexit aren’t going away. It is important to remember, though, that even though the Dogs strategy runs on a 12-month cycle, it should be seen as a long-term approach. In some years, the Dogs will outperform the FTSE 100 index; in other years, they will underperform. However, the strategy’s long-term track record still looks impressive.

Anyone who followed our Dogs strategy for the past 10 years would have nearly tripled their money when dividends are included. They would have made a 128% return even if all the income had been spent. That is comfortably ahead of the FTSE 100, which has returned 55% in share price terms over the period and 96% on a total return basis.

The average annual return, including dividends, for our Dogs over the 18 years of the portfolio is a healthy 13% a year, compared with 7% for the index. While success every year isn’t guaranteed, over a longer timeframe the Dogs have roundly beaten their better-loved competitors.

A table showing long-term performance of the Dogs portfolio and the FTSE 100

 

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