Dividend Yield Strategies in the Canadian Stock Market.doc
Dividend-yield strategies in the Canadian stock market
Sue Visscher; Greg Filbeck
1 January 2003
Financial Analysts Journal
Volume 59, Issue 1; ISSN: 0015-198X
Copyright (c) 2003 ProQuest Information and Learning. All rights reserved. Copyright Association
for Investment Management and Research Jan/Feb 2003
The "Dogs of the Dow" strategy has become an increasingly popular investment strategy for unit
investment trusts, resulting in superior performance for U.S.-based investors. To examine its
effectiveness for Canadian investors, we applied this high-dividend-yield strategy to the Toronto 35
Index for the first 10 years of the index's existence. The 10 topperforming portfolios' higher
compound returns were sufficient to compensate for taxes and transaction costs. Perhaps more
important, both the Sharpe ratio, which measures excess return to total risk, and the Treynor index,
which measures excess return to market risk, indicate that the strategy produced higher risk-
adjusted returns than the Toronto 35. The Dogs strategy also performed well against the broader,
but similar, Toronto Stock Exchange 300 Index.
Dividend-yield strategies have received considerable financial press and academic coverage in
recent years. One of the more popular dividend-yield strategies, the "Dogs of the Dow," involves
purchasing the 10 highest-dividend-yielding stocks on the DJIA on 31 December and rebalancing on
an annual basis (many variations also exist). Bary (2000) has devoted a column to the strategy at
the end of every quarter in Barron's. Working Woman's Mueller and Wuorio (1999) proposed the
Dogs of the Dow as one of six investment strategies worthy of consideration. Success magazine's
Gould (1997) and the Wall Street Journal's McGee (1997) both indicated that unit investment trusts
following a Dow Dogs strategy are becoming ever more popular. McGee pointed out that the
strategy at that time accounted for approximately 75 percent of Prudential's unit sales. In the
academic arena, McQueen, Shields, and Thorley (1997) found that over a 50-year period, the
strategy outperformed the DJIA by 3.06 percentage points (pps). During 2000 alone, the Dow Dogs
strategy posted a gain of more than 6 percent while the DJIA was declining by 6.2 percent ("`Dogs
of the Dow' . . ." 2001).
International interest in this strategy has been growing. Barron's DuBois (1997) noted that broad
European versions of the Dow Dogs strategy (using London, Frankfurt, Paris, and Amsterdam
securities; referred to as "Euro Dog" strategies) are rapidly increasing in popularity. But can the
strategy be replicated in other markets? In the study reported here, we explored whether superior
returns can be earned by following the Dogs strategy in the Canadian stock market.
Dividend-yield strategies belong to the broader class of value investment strategies. Value stocks
are characterized by high dividend yields, low price-to-book ratios, low price-to-earnings ratios, and
low expected growth rates. Growth stocks are classified as stocks exhibiting the opposite
characteristics from value stocks. The logic behind value investing is that investors typically
overreact negatively to adverse company financial news (creating value stocks) and overreact
positively to superior company financial news (creating growth stocks). When the market adjusts for
these overreactions, so the logic goes, value stocks will outperform growth stocks. Although value
investing was less successful during the 1990s than in previous decades, numerous studies have
found that longterm value strategies tend to outperform the market in the U.S. financial markets
(Basu 1977; Ambachtsheer 1977; Ambachtsheer and Farrell 1979; Estep, Hanson, and Johnson
1983; Sorensen and Williamson 1985; Harris and Marston 1994; Chan, Jegadeesh, and Lakonishok
Haugen (1997) reviewed evidence from a number of studies on market overreaction to company
announcements and found that value stocks are persistently undervalued compared with growth
stocks. In addition, value stocks have exhibited superior performance in conjunction with positive
earnings surprises (La Porta, Lakonishok, Shleifer, and Vishny 1997), with low-momentum stocks
(Asness 1997), and with periods of expansive monetary conditions (Jensen, Johnson, and Mercer
The effectiveness of dividend-yield strategies in enhancing portfolio returns has been debated for
many years. Some studies have suggested that little or no relationship exists between dividend
yield and share price returns (Black and Scholes 1974; Goetzmann and Jorion 1993, 1995). Many
other studies, however, have identified a positive relationship between dividend yield and share
price (Fama and French 1988; Hodrick 1992; Grant 1995). Benjamin Graham (see Rea 1977)
reported an average compound growth rate between 1925 and 1975 of 19.5 percent for U.S. stocks
that had a dividend yield greater than two-thirds of the AAA bond yield, compared with a 7.5
percent return for the DJIA.
Variations of the dividend-yield relationship, such as a "U-shaped" relationship between dividend
yield and stock returns, have also been debated (Litzenberger and Ramaswamy 1979; Blume 1980;
Elton, Gruber, and Rentzler 1983; Keim 1985, 1986; Christie 1990). A U-shaped relationship would
indicate that both companies with high-dividend yields and companies that do not pay dividends
tend to outperform companies with dividend yields between the extremes.
Another argument is that the effectiveness of high-dividend-yield strategies is tied to the economic
cycle (Gombola and Liu 1993b) and to the stability of beta as a measurement of risk (Gombola and
In summary, most studies offer qualified support for the effectiveness of dividend-yield strategies.
The success of value-based strategies has also been investigated in international markets. Keppler
(1991) discovered that global equity investors can achieve excess risk-adjusted returns over long
holding periods by selecting markets with higherthan-average dividend yields. He focused on the
dividend yields of national country indexes and concluded that higher risk-adjusted returns were
available in markets with the highest dividend yields. Capaul, Rowley, and Sharpe (1993) analyzed
the performance of value stocks versus growth stocks for six countries in the 1981-92 period. Their
portfolios of value and growth stocks consisted of the securities within each index that had the
lowest P/Bs (the value stocks) and the highest P/Bs (the growth stocks). They found that, as
measured by both raw returns and risk-adjusted returns, value stocks outperformed growth stocks
in each country during the period studied. Cai (1997) discovered that value stocks outperform
glamour (i.e., growth) stocks in the Japanese equity market.
Do value strategies work in Canada? The evidence so far is mixed. Elfakhani (1993/1994) pointed
out that the U.S. and Canadian markets have structural differences. And because of the Canadian
market's lower trading volume, he argues that opportunities to exploit anomalous relationships
would be enhanced in the Canadian market. Controlling for January and size effects, Kryzanowski
and Zhang (1992) found that the stocks with the highest returns ("winners") continue to outperform
stocks with the lowest returns ("losers") over the next one- and two-year periods. They found that a
contrarian investment strategy (based on losers outperforming winners) underperformed for test
periods up to 10 years. Bauman, Conover, and Miller (1998) extended the work of Capaul et al. by
lengthening and updating the time period and examining 21 established markets, including Canada.
Bauman et al. expanded the classification scheme to consider three additional measures of value
stocks-P/E, price to cash flow, and dividend yield. Value portfolios generally outperformed growth
portfolios in this study. In the Canadian market, the value stock portfolio outperformed the growth
portfolio on both a raw-return and a risk-adjusted basis.
Dogs of the Dow Strategy
The Dow Dogs strategy was first mentioned in the Wall Street journal's "Your Money Matters"
column in 1988. At that time, John Slatter, an analyst for Prescott, Ball, and Turben of Cleveland,
Ohio, concluded that for the 1972-87 period, the average (not compounded) annual return for the
high-yield stocks was 18.4 percent, compared with 10.8 percent for the Dow. Knowles and Petty
(1992) and O'Higgins and Downes (1992) published books confirming these results over longer time
McQueen et al.'s study of the phenomenon produced mixed results. They found that a "Dow 10"
strategy outperformed a "Dow 30" strategy over a 50-year holding period by approximately 3 pps.
Breaking the sample into five 10-year periods, the authors found that the strategy was successful in
each period to varying degrees. Although they found the strategy to work statistically, they argued
that the strategy would lose effectiveness after adjustment for risk (in terms of company-specific
risk from inadequate diversification), transaction costs, and tax treatment. After they incorporated
these factors, the Dow 10 strategy's premium over the Dow 30 shrank to 0.95 pps.
McQueen et al. also tested two variations on the Dow strategy-a "Dow 5" strategy and a "Dow 15"
strategy. They found the Dow 5 to be more effective than the Dow 10 in terms of differences in
returns, but higher turnover (averaging 46 percent a year) and higher total risk were the "costs" of
these additional returns. The Dow 15 was better diversified but provided lower returns.
We applied the Dow strategy to the British stock market between 1984 and 1994 (see Filbeck and
Visscher 1997). Measuring both raw returns and returns adjusted for risk, we concluded that the
strategy was not effective, possibly because of the composition of the FTSE 100 Index.
In this study, we investigated whether the Dow dividend-yield strategy is effective in the Canadian
On a yearly basis between 1987 and 1997, we compared the performance of the 10 highest-
dividend-- yielding (Top 10) stocks in the Toronto 35 Index against the performance of the Toronto
35 and the Toronto Stock Exchange (TSE) 300 Composite Index.
The Toronto 35 consists of Canada's largest corporations and represents a cross-section of
industries. The index, created in 1987, was designed to closely track the broader TSE 300, which
was introduced in 1977. Listing criteria for the TSE 300 include minimum levels for market value,
for trading volume, and for trading value. Stocks listed on the Toronto 35 must be in the TSE 100
and rank in the top 125 of the TSE 300 in terms of volume traded, value traded, and total
transactions executed for the previous 12 months. All TSE 300 major industry groups with at least a
5 percent weighting must be represented in the Toronto 35 index. We obtained the constituent
companies, as well as returns for both indexes, from the TSE Review.
We hypothesized that the "Canadian Dogs" strategy would beat the Toronto 35 from which it was
drawn on a hedged and unhedged basis. We also tested whether the Canadian Dogs would beat the
We collected dividend yields on all of the Toronto 35 companies on the last trading day of July 1987
through 1997 from Research Insight. We used 31 July as our rebalancing date for two reasons.
First, the Toronto 35 began trading in March 1987 and we wanted to give the companies' stocks and
the index a few months to stabilize. Second, the Canadian tax year ends 31 December and we
wanted to avoid any effects of trading for tax reasons.
The 10 companies with the highest dividend yields composed the equally weighted Top 10 portfolio
each year. The monthly returns for each stock include both the price change and dividends divided
by the beginning price. We calculated the Top 10 portfolio return by investing C$10,000 in each
stock on 1 August. Each C$10,000 investment was increased by each individual stock's August
return. We added the end-of-August stock values to determine the portfolio value. We used the
percentage change in portfolio value during the month for the monthly portfolio return. We
multiplied the Canadian dollar value of each stock investment at the end of August by each stock's
September return, summed the 10 stock values, and calculated the September portfolio ending
value and return. We repeated this process for each of the 12 months. Then, we repeated the
process for the following year by investing C$10,000 in each of 10 (potentially new) stocks on 1
Table 1 provides the constituent stocks by year and notes the number of companies that stayed on
the list year by year and the yearly turnover. During the 10-year period, 21 stocks were members
of a Top 10 portfolio for at least a year; 4 stocks appear on the list every year.
The Toronto 35 differs from the DJIA in that it includes utilities and many financial institutions.
Seven banks, two phone companies, and one electric utility appeared at least once in the Top 10
portfolios. The low (25 percent) average annual turnover consisted of two or three stocks in eight of
the years and four stocks in one year.
Results vs. the Toronto 35
We report the returns of the portfolios versus the Toronto 35 in Table 2. Panel A shows that the Top
10 (TT) portfolios' compound annual returns were between 1.2 pps and 20.4 pps greater than those
of the index (T35) in eight years and were lower than the index by relatively small amounts (2.8
pps and 3.6 pps) in the other two years.1 We also computed average annual compound returns
over the six 5-year horizons and the 10-year horizon. Panel B shows that the Top 10 portfolios beat
the index in all six of the 5-year periods and the entire 10-year period by 3-6 pps. Table 1.
Moreover, in the face of high marginal tax rates, the strategy could be considered a success in at
least half of the years, with before-tax returns 9 pps or more higher than index returns. Although
the effective tax rate on this high-dividend-payout strategy would be higher than for a portfolio
mimicking the index (because of differential tax treatment between dividends and capital gains), the
strategy remains superior. For example, if we assume a 40 percent marginal tax rate for the
strategy and a 20 percent marginal tax rate for the Toronto 35 (which would be an unrealistically
large differential), the strategy would have resulted in C$238,170 by 31 July 1997 versus
C$200,120 for the Toronto 35.(2)
In addition, considering the relatively low turnover of the strategy, transaction costs should not
diminish the strategy's effectiveness. Assuming that annual transaction costs are approximately I
percent of portfolio value, the strategy would still prove superior, resulting in C$225,390 by 31 July
Because the standard deviations of the monthly returns were relatively large, only two of the single-
year Top 10 portfolios had returns that were statistically significantly higher than the index. Three of
the 5-year periods and the 10-year period produced statistically significant higher returns for the
Top 10 portfolios.
Although comparison of raw return data gives us some information about the performance of each
of the portfolios, it provides little information about the level of risk in the portfolios. Thus, we
calculated two commonly used risk-adjusted measures for comparison purposes. Both emerged
simultaneously with the capital asset pricing model in 1966 to permit appropriate comparison of
returns among portfolio managers of similar style.
The Sharpe (1966, 1994) ratio considers excess return per unit of total risk. It is the appropriate
measurement of risk-adjusted return when the investor is not well diversified and is exposed to
some level of company-specific risk. We present the results of the Sharpe ratio test in Table 3. As
the portfolios' compound returns show, the Top 10 portfolios outperformed the Toronto 35 as
measured by the Sharpe ratio in eight single-year periods (Panel A) and all of the multiyear periods
(Panel B). This superiority resulted in spite of the fact that the Top 10 portfolios entailed higher risk
in half of the single-year periods and almost all of the multiyear periods. Table 2.
The Treynor (1966) index uses systematic risk, measured by beta, instead of total risk in calculating
risk-adjusted returns. Therefore, the Treynor index is the appropriate measurement of riskadjusted
return when the investor is well-diversified and is not exposed to company-specific risk. We present
the Treynor comparisons in Table 4.4 Again, the Top 10 portfolios outperformed the Toronto 35 in
the same eight single years and all of the multiyear periods. Although the standard deviations used
in the Sharpe ratio calculations indicated somewhat higher total risk for the Top 10 portfolios, the
level of systematic risk was usually lower. The portfolio beta for the single-year periods ranges from
0.52 in 1995-1996 to 1.54 in 1990-1991; it was greater than 1.00 in only three of the individual
years. The average betas for the single-year and 10-year periods is lower than 1.00.
Results vs. the TSE 300
The Toronto 35 and TSE 300 had similar returns during the period covered by this study. Over the
10-year period, the Toronto 35 monthly return averaged 0.81 percent with a standard deviation of
4.13 percent; the TSE 300 numbers were slightly lower at, respectively, 0.78 percent and 3.91
percent. The standard deviations can be better understood by examining the range of returns over
the 10 years. The maximum monthly returns for the indexes were 9.10 percent for the Toronto 35
and 7.64 percent for the TSE 300. Not surprisingly, the worst returns occurred in October 1987,
when both indexes lost about 22.5 percent (the Top 10 portfolio lost only 13.8 percent). A
regression of the indexes' returns against each other produced a 0.94 beta. The indexes' returns
were highly correlated, with an R^sup 2^ value of 0.96. Table 3. Table 4.
We present a comparison of the Top 10 portfolios' performance with that of the TSE 300 (and of the
T35) in Table 5. The Top 10 portfolios' compound risk-adjusted returns beat the TSE 300 in eight
single years and in all of the multiyear periods. The t-test shows similar results for the two indexes,
with the exception of 1992-1993 and 19931994. In those two years, the compound returns of the
indexes were quite different, with the TSE 300 beating the Toronto 35 in the first year, and vice
versa in the second. Statistically significant differences were fewer for the Top 10 portfolios versus
the TSE 300 than versus the Toronto 35; against the TSE 300, only one single-year (versus two for
the Top 10 against the Toronto 35) difference was significant; for the 5-year periods, one difference
(versus three) was significant.
Both sets of risk-adjusted returns indicate that the dividend-yield strategy holds up against the
broader TSE 300 as well as against the Toronto 35. The Sharpe ratio results show a loss in only one
year (1993-1994) for the Top 10 and virtual ties for two years. The Top 10 portfolios clearly
dominated the TSE 300 in all the multiyear periods. The Treynor index values are similar, with the
exception of the same two single years noted earlier. The Top 10 outperformed the TSE 300 in
1993-1994 and underperformed in 1992-1993. Nevertheless, the Top 10 outperformed the TSE 300
in eight single years and in all multiyear periods.
We found that the high-dividend-yield strategy worked for the Toronto 35 Index for the first 10
years of the index's existence for Canadian investors. The Top 10 portfolios' higher compound
returns were sufficient to compensate for taxes and transaction costs. Perhaps more importantly,
we found that the strategy produced higher riskadjusted returns. The Sharpe ratio, which measures
total risk, indicates that the dividend-yield strategy was a success. This ratio is an important
measure because the small number of industries represented in the Top 10 portfolios over the 10
years would not produce sufficient diversification to consider market risk alone. If an investor has
other market investments and this strategy is only part of an overall portfolio, however, the Treynor
index, which measures systematic risk, is the relevant indicator of risk. The Top 10 portfolios
exhibited superior performance when adjusted for systematic risk in the Treynor test. The strategy
also performed well against the broader, but similar, TSE 300 index. Table 5.
Sue Visscher and Greg Filbeck
Sue Visscher is associate professor of finance at the University of Toledo, Ohio. Greg Filbeck, CFA, is
senior vice president of the Schweser Study Program and adjunct professor of research, University
We would like to thank Ed Nelling and Dianna Preece for their helpful comments.
1. For each year, we computed and then geometrically compounded the 12 monthly percentage
changes in the total return index for both the Toronto 35 and TSE 300 to produce the annual market
2, C$100,000 x [1 + (0.1511 x 0.6)110 = C$238,170; C$100,000 x [1 + (0.0898 x 0.8)110 =
3. If 1 percent of annual portfolio value is used to pay for transaction costs, the overall geometric
return for the time period falls to 14.11 percent. Thus, the terminal value to the strategy would
have been C$100,000 x (I + 0.1411 x 0.6)10 = C$225,390. With an annual average turnover of 2.5
stocks (rounded to three stocks), a total of 13 trades a year would result (from holding the seven
remaining stocks adjusted to retain equal weighting, selling the three stocks that are not
part of the next year's portfolio, and buying the three replacement stocks that would be included in
the portfolio revision). If the cost per trade is assumed to be $20, total transaction costs would be
C$260 a year. This cost would represent less than 1 percent of the end of the first-year portfolio
value (C$260/C$115,110 = 0.226 percent). In subsequent years, the percentage of total portfolio
value represented by transactions would decline as the portfolio value rose. Thus, the use of I
percent of portfolio value allocated to transaction costs is a conservative estimate for determining
the impact of costs on terminal portfolio value.
4. To compute portfolio betas, we regressed the monthly Top 10 portfolios' returns against both
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