The Dobermans Of The Dow Have Outperformed In Bull And Bear Markets

Five years ago, I introduced to Forbes readers a stock strategy called the Dobermans of the Dow. This is my annual strategy update.

The Dobermans of the Dow is a screen I invented as an alternative to the widely followed Dogs of the Dow strategy. Whereas the Dogs of the Dow only ranks stocks by their dividend yield, the Dobermans screen favors high quality companies trading at attractive valuations. The selection criteria consists of two steps:

1) Rank the 30 Dow stocks by Return on Equity (ROE), keep the top 20.

2) Rank the remaining 20 names by Free Cash Flow Yield, keep the top ten.

Those final ten stocks are your Dobermans.

Historically, a hypothetical Dobermans of the Dow portfolio has outperformed the Dow Jones Industrial Average (DJIA) and the S&P 500 Index. Since 2000, the Dobermans portfolio rebalanced annually has generated a cumulative return of 810 percent, which is more than double the long-term performance of the Dow and S&P 500.

How Did The Dobermans Perform In 2022?

Last year, the Dobermans of the Dow averaged a total return of -8.2%. I consider that an OK relative return in a tough year. By comparison, the Dow Jones Industrial Average (DJIA) fell 6.9% in 2022, while the S&P 500 index lost -18.1% and the Nasdaq Composite declined -32.5%.

The table below shows how the individual names from last year’s list performed.

The last year has reminded investors why it’s important to have an investing approach you can rely on over a full market cycle.

Many of the speculative stocks that were supercharged by a Fed-driven liquidity surge in the pandemic got pulverized in 2022. Meanwhile, tried and true cash flow generators—like many of the stocks populating the Dow Jones Industrial Average—outperformed.

Interestingly, as financial conditions tightened in 2022, the Dow outperformed the S&P 500 by the widest margin since 1933.

The Dobermans Have Outperformed In Bear Markets

One of the things I like about the Dobermans of the Dow strategy is that it has done well in bull and bear markets. That’s important to me as an investor because bear markets are tough enough as is. Outperforming during volatile markets helps smooth out the investing journey.

Since 2000, equity investors have traversed five particularly challenging years that occurred during bear markets. Those years include: 2000, 2001, 2002, 2008, and 2022. As shown in the table below, the Dobermans of the Dow strategy averaged an annualized return during those years of -8.8%, which was better than the Dow (-12.8%), S&P 500 (-19.6%), and Dogs of the Dow (-9.3%).

There are a variety of risk-adjusted return measures for comparing investments. One metric I prefer is called the ‘Gain-to-Pain Ratio’, which measures the amount of gain an investment produces relative to the amount of downside pain required to achieve that return.

In the case of the Dobermans, we can look at the Gain-to-Pain ratio by calculating the sum of all the yearly gains divided by the sum of all the losses from negative years. Since 2000, the Dobermans have beat the Dow, S&P 500, and Dogs of the Dow with a Gain-to-Pain ratio of 5.5.

Why have the Dobermans outperformed on a risk-adjusted basis? In my view, it’s because of the factors in the screen.

The first factor is Return on Equity. The Dobermans screen favors companies with high profit margins, which is a key fundamental trait that helps survive economic downturns.

The second factor is Free Cash Flow Yield. The Dobermans screen favors companies that produce high amounts of cash flow relative to their market value. This bias toward value can help during bear markets, because the majority of losses are usually attributed to valuation corrections.

So, if you’re worried the 2022 bear market will continue in 2023, the Dobermans of the Dow offers a potentially prudent way to stay invested through the storm. And since the screen has also done well in bull markets, you can consider it an “All Weather” type of portfolio strategy.

Meet The 2023 Dobermans of the Dow

Finally, let’s meet the the official lineup for 2023.

New members to this year’s list include: Chevron, Merck and Apple.

Disclosure: I own shares of DOW, AXP, CVX, VZ, CSCO, UNH, AMGN, MMM,MRK and AAPL in client accounts that I professionally manage. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation. Past performance is not always indicative of future results.