The Closest You Might Get To Investing Like Warren Buffett
December 14, 2017

The Closest You Might Get To Investing Like Warren Buffett

Who wouldn’t want to invest like Warren Buffett? His investments have long beaten the performance of the S&P 500. Plenty of mutual fund and hedge fund managers have tried to do the same. But most fail. That’s why mere mortals should stick to low-cost index funds.

Some people, however, enjoy the added risk of trying to beat the market. If you’re one of them, let me offer a suggestion: There is a simple method with a market-beating record. It doesn’t win every year or even every decade. But its long-term record has beaten the U.S. market index. It takes about ten minutes a year, combining two investment styles from Warren Buffett’s biggest mentors.

When the Oracle of Omaha was nineteen years old, he read Benjamin Graham’s book, The Intelligent Investor. He soon became Graham’s best student at Columbia University. In 1954, Graham hired Buffett to work at his investment firm.

Benjamin Graham had a strong, market-beating record. He taught Buffett to look for cheap stocks, relative to earnings and book values. Many were beaten-up. That’s why Buffett called them cigar-butt stocks. They could get a few (almost free) profitable puffs before selling them.

A few years later, two other men helped to tweak Buffett’s method. The first was Philip Fisher. He wrote Common Stocks and Uncommon Profits. The second was Charlie Munger. He is Buffett’s long-time friend and right-hand man at Berkshire Hathaway.

While Graham taught Buffett to obsess over price, Fisher and Munger wanted quality instead. They sought strong businesses–those with solid earnings that would have even greater earnings later. Fisher wanted stocks that he could hold forever.

Dozens of books explain how to invest like Warren Buffett. One of the first was Robert Hagstrom’s, The Warren Buffett Way. But it’s silly to think we could read a few books and invest like Buffett. That’s like painting the Sistine Chapel after reading about Michelangelo.

This brings me back to that 10-minute method. It’s called Dogs of the Dow. It doesn’t require a Buffett-like brain. But it has beaten the market.

Michael O’Higgins popularized the strategy in his 1991 book, Beating The Dow. He said investors should buy cheap stocks (like Graham) but select them from the Dow Jones Industrials­ – an elite selection of robust businesses. They might not promise the sort of growth that would have attracted Philip Fisher. But most have strong fundamentals that could survive financial storms.

O’Higgins said investors should look at the ten highest dividend-yielding stocks on the Dow. Often, the prices of such stocks have been beaten down. For example, if a stock’s price were $100 a share and it paid $2 per year in dividends, it’s dividend payout would be 2 percent. But if that stock’s price fell to $50, and the dividend payout remained at $2 per share, the dividend payout would now be 4 percent per year. It often takes a fallen price to produce a high dividend yield.

O’Higgins then said investors should buy the five lowest-priced stocks among the ten highest yielders. On January 1, 2017, the Dogs of the Dow included Verizon, Pfizer, Cisco Systems, Coca-Cola and Merck.

Investors would hold the stocks for a year. Then, they would sell the stocks that no longer fit the original criteria. They would trade them for the stocks that do. From January 1972 to September 30, 2017, the S&P 500 averaged a compound annual return of 10.51 percent per year. During the same time period, the Dogs of the Dow averaged a compound annual return of 14.14 percent per year.

Ten-Highest Yielding Dow Stocks
January 1, 2017

Symbol Company Price Yield Lowest Priced Dogs?
VZ Verizon 53.38 4.33% Yes
PFE Pfizer 32.48 3.94% Yes
CVX Chevron 117.70 3.67% No
BA Boeing 155.68 3.65% No
CSCO Cisco Systems 30.22 3.44% Yes
KO Coca-Cola 41.46 3.38% Yes
IBM International Business Machines 165.99 3.37% No
XOM ExxonMobil 90.26 3.32% No
CAT Caterpillar 92.74 3.32% No
MRK Merck 58.87 3.19% Yes

Critics of the strategy call this data mining. Strategies that win during one time period usually fail the next. The Dogs of the Dow could also fail for years. They haven’t performed as well since O’Higgins’ book was published. But they still beat the market. Between 1991 and 2017, the S&P 500 averaged a compound annual return of 9.9 percent per year. The Dogs of the Dow averaged a compound annual return of 11.8 percent per year.

Dogs of the Dow vs. S&P 500

Dogs of the Dow vs. S&P

As of December 1, 2017, the Dogs of the Dow were General Electric, Verizon, Pfizer, Coca-Cola and Cisco Systems.

Ten-Highest Yielding Dow Stocks
December 1, 2017

Symbol Company Price Yield Lowest Priced Dogs?
GE General Electric 17.88 5.37% Yes
VZ Verizon 51.25 4.60% Yes
IBM International Business Machines 154.76 3.88% No
XOM ExxonMobil 83.46 3.69% No
CVX Chevron 119.51 3.61% No
PFE Pfizer 36.35 3.52% Yes
MRK Merck 55.87 3.44% No
KO Coca-Cola 45.97 3.22% Yes
CSCO Cisco Systems 37.60 3.09% Yes
PG Procter & Gamble 90.36 3.05% No

But there’s no guarantee that this method will beat the market. For example, between 2007 and 2017, the S&P 500 earned a compound annual return of about 6.9 percent per year. It beat the Dogs of the Dow, which averaged a compound annual return of 6.4 percent per year. That doesn’t include taxes or transaction costs.

Large-cap value stocks, however, have had their share of struggles. The S&P 500 has beaten Vanguard’s large-cap value stock market index over the past 23 years.

That won’t always happen. When value stocks are back in vogue, the Dogs of the Dow might run once again.

Related Articles

This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.