Testing the Dogs of the TSX

The Dogs of the TSX is a simple stock picking strategy that appeals to dividend investors. Those who follow it faithfully buy an equal amount of the top 10 yielding stocks in the large-cap S&P/TSX 60 index each year.

While the basic Dogs strategy is simple, I back tested several different takes on it using MoneySense‘s Bloomberg terminal. I’ll show you two of them today.

Just like the basic Dogs strategy, both variants buy an equal amount of the top 10 yielding stocks in the S&P/TSX 60 each year. But they calculate yield in different ways.

The first variant uses indicated yield, which is based on a company’s announced dividend rate. The second uses trailing yield, which is based on the amount of dividends paid over the last 12 months.

The difference between the two becomes important when a stock’s dividend changes in a big way. For instance, way back in 2008 Teck Resources (TCK.B) was foundering. The company paid a dividend in the summer, but it stopped paying them when the credit crunch took hold later in the year.

At the end of 2008, Teck had an indicated dividend yield of 0% because it wasn’t paying dividends. However, due to its depressed share price, its trailing yield was 8.3%. Teck passed, or failed, the Dogs test depending on which one was used.

The following screenshots show the returns generated by the two variants. The first shows the history of the indicated yield method and the second that of the trailing yield approach.

(In each case the tests used 12 years worth of data, ending Dec. 31, 2014, with equally-weighted portfolios and annual rebalancing.)

The indicated yield method largely followed the index over the period, but lagged in recent times. On the other hand, investors using the trailing yield handily beat the index over the whole period.

A good part of the return difference was attributable to stocks, like Teck, that were purchased in bad times and then recovered.

For instance, Teck climbed from $6.02 per share at the end of 2008 to a whopping $36.82 per share in only 12 months. It gained 512% in 2009 and, as a result, pushed the trailing-yield portfolio up significantly.

Problem is, it wasn’t clear—at the time—that Teck would survive. If history played out differently, the company might have been a big disappointment for Canadian dividend investors. (Much like Laidlaw and Yellow Media.)

I hasten to add that, while the back tests are interesting, they only cover a short time period, which makes them far from definitive.

As a result, the winning variant will only truly become apparent in the fullness of time.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of Feb. 12. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase—barring some calamity.

Notes

Source: Bloomberg, Feb. 12, 2015

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

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