The Dogs of the Dow Theory – Is It Valid?

Abstract

The Dogs of the Dow theory has been a popular tool in the financial market. But while the theory is simple, there have been mixed findings on its validity. Using U.S. data from 2000 through 2017, this paper identifies how consistently an investment strategy that follows the Dogs of the Dow theory outperforms the average market. The results show that the theory has not worked well in the recent U.S. market when trading costs and taxes are included. Rather, holding an equally weighted investment of all firms is more likely to outperform the Dow Jones Industrial Average index and the Dogs of the Dow strategy in the long term.

Does the Dogs of the Dow Theory Work at the Sectoral Level?

“…We find that the DoD theory is not confirmed even at the sectoral level, except in one sector (energy), if tax and trading costs are included. This supports the findings by Hirschey (2000) and Kim (2019), among many others. If investors narrow their investments down to the 5 highest dividend-yield firms and rebalance their portfolios once a year on the last trading day, their returns will be higher than the average return of ETF in all 11 sectors.…”

“…However, there is no robust consensus on the validity of the theory in the market. Some have found the theory to be well confirmed (Chong & Luk, 2010;Tissayakorn et al, 2013;Soomro & Haroon, 2015;Yan et al, 2015), whereas other studies contradict the theory (Domian et al, 1998;Hirschey, 2000;Da Silva, 2001;Kim, 2019). Yan et al (2015) supported the validity of DoD theory by demonstrating higher returns upon following this strategy than the average market return in Taiwan.…”

“…Some years of outperformance with the strategy turned out to be non-statistically significant. Using data from 2000 to 2017, Kim (2019) also showed that the theory does not work well in the U.S. equity market if both tax and trading costs are included.…”