The Dogs and Puppies of STI

Many academia and literature says that active investors cannot beat the index. However, if you believe that this is true but still want to beat the index, then it follows that the key to beating the index must lies within the index itself, i.e. the portfolio of stocks that beat the index must come from the index component stocks.

In my previous post, I mentioned that an equal-weighted portfolio of the Straits Times Index (STI) component stocks can beat the index easily. In this post, we will discuss whether a "Dogs of STI" investment strategy can beat the index and even outperform the equal-weighted portfolio of STI component stocks.

The Dogs of STI replicates the investment strategy of the Dogs of the Dow. In this strategy, the 10 highest yielding Dow Jones Industrial Average (DJIA) component stocks are selected for investment in the following year. This strategy has returned 10.8% per annum over the past 20 years, matching the returns of DJIA and beating the Standard and Poor's 500 index's return of 9.6%.

What is the rationale behind the Dogs of the Dow investment strategy? Proponents of the strategy argue that blue chip companies do not change their dividends regularly to reflect changes in business conditions whereas stock prices regularly fluctuate according to business conditions. Hence, a stock that is higher yield than average would most likely be near the bottom of the business cycle and the stock price is likely to recover more than that of lower-yielding stocks. It suggests that the management of the companies believes their stocks are oversold and are willing to back them up by paying a relatively high dividend. By investing in the Dogs of the Dow, investors gain both by the higher price appreciation and the higher dividend yield.

Besides the Dogs of the Dow, there is a related investment strategy known as the "Small Dogs of the Dow" or "Puppies of the Dow". In this strategy, the same 10 stocks are selected as in the Dogs of the Dow. From this list, the 5 lowest-priced stocks are selected as the Puppies of the Dow. This smaller portfolio outperforms even the Dogs of the Dow, returning 12.5% versus 10.8% for the Dogs of the Dow over a 20-year period. 

So, how would a "Dogs of STI" and "Puppies of STI" portfolio perform? The table below shows the Dogs and Puppies of STI over a 13-year period since 2000 (Please refer to the previous post on Who Says You Can't Beat the Index? for limitations of the stock price data). Stocks highlighted in orange are the Puppies of STI while stocks highlighted in yellow make up the rest of the Dogs of STI.

Dogs and Puppies of STI Selected at End of Year

 

Returns of Dogs and Puppies of STI in Following Year (W/o Dividends)

Returns of Dogs and Puppies of STI in Following Year (With Dividends)

As shown above, the Dogs of STI outperforms the STI and even the equal-weight portfolios of STI and STI without the heavy weights (i.e. DBS, OCBC, Singtel and UOB). The average return including dividends is 19.3%, higher than STI's 6.7%, equal-weighted STI's 14.1% and equal-weighted STI without the heavyweights of 15.4%. The Puppies of STI performed even better than the Dogs of STI, returning 21.0% over the same period.

The outperformance of both the Dogs and Puppies is not due to dividends alone. Without dividends, the price appreciation (12.7% for Dogs and 13.3% for Puppies) already outperformed that of the STI (3.9%), equal-weighted STI (9.7%) and equal-weight STI without the heavyweights (11.0%). The inclusion of dividends further increased the outperformance of the Dogs and Puppies. The table below shows the outperformance relative to the STI, equal-weighted STI and equal-weighted STI without the heavyweights with and without dividends included.

	Dogs of STI		Puppies of STI
	No Dividends	With Dividends	No Dividends	With Dividends
STI	8.8%	12.6%	9.4%	14.3%
Equal-weighted STI	3.0%	5.2%	3.6%	6.9%
Equal-weighted STI w/o Heavyweights	1.7%	3.8%	2.2%	5.5%

On a dollar basis, over a 13-year period ending in Dec 2013, a $10,000 investment in the Dogs of STI with dividends reinvested would become $99,158 while a $10,000 investment in the Puppies of STI would become $119,182. This compares very well with STI ($23,235), equal-weighted STI ($55,554) and equal-weighted STI without the heavyweights ($64,369). So, dogs (and puppies) are Man's best friends apply to investors as well :)


See related blog posts:

• The Dogs and Puppies of STI for 2015
• Who Says You Can't Beat the Index?
• The Bounceback Portfolio of STI