Dear Mr. Berko:

Would you explain the “Dogs of the Dow” concept to me? How does it work, how the stocks are picked and which stocks are being used for this year? Can you also give me some idea how this concept has worked in each of the past 10 or so years?

B.L., Durham, N.C.

Dear B.L.:

The 30 stocks that comprise the Dow Jones Averages are, historically, supposed to be the creme de la creme of all stocks listed on the Big Board, the blue chip beauties of American industry and an elite club of exclusive titans that represent the biggest and most prestigious companies of Wall Street.

The strategy behind this Dogs of the Dow concept requires that you buy equal dollar amounts of the 10 highest-yielding Dow Jones Industrial issues and hold them for one year. In doing so, you have selected those stocks, that are supposed to be the least expensive issues relative to their peers. Then at the end of each year you adjust your portfolio, with equal weighting, to include the new Dogs of the Dow.

The theory behind this is that you continue to buy the classiest companies when they are temporarily out of favor and their share prices are low. At every year’s end, those that have rebounded should be sold and the proceeds are used to purchase the new year’s list of laggards.

It supposedly works because those 30 industrial issues are the best-known stocks on the Street, have steel-strong balance sheets and enough financial horsepower to ride through a rough market.

In the last 20 years, this technique has failed only three times. Its worst failure was the disastrous market of 2002 when the Dogs of the Dow lost 8.9 percent. However, in the past 10 years, the Dogs of the Dow returned an average annual 18.3 percent.

During the tech bubble of the late 1990s, the Dogs were up 29 percent in 1996, 22 percent in 1997, nearly 11 percent in 1998 and just 4 percent in 1999. But these Dogs can still hunt. During the three disastrous bear market years – between 2000 and 2002 – the Dogs were up 6.4 percent in 2000, down 4.9 percent in 2001 and down 8.9 percent in 2002, significantly outperforming the Dow, the Russell 1,000, the Nasdaq and the Standard & Poor’s 500.

In 2003, the Dogs of the Dow were plus 28.7 percent vs. 28.3 percent for the Dow. So their bite is really fiercer than their bark. According to Chuck Carlson, chief executive officer of Horizon Investments, the strategy of buying the 10 worst-performing Dow stocks each year, beginning in 1931, “turned a single investment of $1,000 into almost $3 million” by year’s end 2003.

The 2004 Dogs of the Dow portfolio are:

1) Eastman Kodak Co. (EK-$28.75), which was down 26.7 percent in 2003; its 50-cent dividend yields 1.75 percent.

2) AT&T Corp. (T-$20.50), which was down 22.3 percent last year; its 95-cent dividend yields almost 5 percent.

3) Merck & Co. Inc. (MRK-$48.25), which was off 18.4 percent last year; its $1.48 dividend yields 3 percent.

4) SBC Communications Inc. (SBC-$25) was only down 3.8 percent in 2003 and its $1.25 dividend has a 5 percent yield.

5) Johnson & Johnson (JNJ-$58), was also down 3.8 percent in 2003; the 96-cent dividend has a 1.7 percent current return.

6) Wal-Mart Stores Inc. (WMT-$58) was plus 5.03 percent last year; its piddling 36-cent dividend yields 0.6 percent.

7) Microsoft Corp. (MSFT-$27.25) was up 5.8 percent in 2003 and its paltry 16-cent dividend pays an anemic 0.59 percent.

8) E.I. du Pont de Nemours and Co. (DD-$45) was plus 8.2 percent last year; the $1.40 dividend yields 3.1 percent.

9) Coca-Cola Co. (KO-$51) rose 15.7 percent in 2003; the 88-cent dividend yields 1.75 percent.

10) Procter & Gamble Co. (PG-$103) was up 16.2 percent last year and the $1.82 dividend has a 1.75 percent yield.

Of note, the only other time MSFT was a Dow Dog was in 2000 when it fell 63 percent and was the second-worst Dow stock. The next year it was the best-performing Dow stock and rose 52.9 percent. So MSFT watchers may have an interesting year.

It can be a very expensive proposition to purchase equal dollar amounts of each issue. The commission costs will eat you alive. Perhaps the best way to follow this unique strategy is to consider purchasing $5,000 or $7,000 or $12,000 or $77,000 (or whatever dollar amount makes you comfortable) in a unit trust that does it all for you.  The unit trust collects all the dividends, makes all changes at year-end, calculates your gains, sends you quarterly and annual statements. It’s a no fuss, no muss and no bother way to make the Dogs of the Dow hunt for you.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.