Beating the Dow [Paperback]

2nd edition (2000) with Johns Downes, 259 pages

O'Higgins' basic method for selecting out of favour stocks from the Dow Jones Industrial Average can be explained in a single sentence: list the ten stocks from the Dow with the highest dividend yield, and then select the five with the lowest share prices from these ten. Buy an equal weighting in each of them and after one year, sell and start again.

So you could be forgiven for wondering how he manages to fill a book. I found significant chunks to be of little interest in understanding why and how his method has worked. For example, I didn't find his introduction on why stocks are the best long term investments, or his potted history of each of the Dow constituents (which takes up just under half the book) added much. (The history of the Dow stocks also reads as if at least the updates for the 2nd edition were written in a considerable hurry.) However, if you are new to equity investing these parts may be more useful to you. Even so, I cannot understand why O'Higgins included the addresses for each of the Dow stocks in the main body of the book when his method is a mechanical one which requires that you do not do any specific stock research or have any contact with companies.

I bought this book with a particular aim in mind: to understand the background better to see how it could be applied in the UK. For example, some people try to apply it to the FTSE 100 and others to the FT 30 index and others use the lowest market capitalisation rather than the lowest share price as the second filter.

After reading the book I concluded that the FT 30 index with lower share prices (i.e. with minimum changes to O'Higgins' original method for the Dow) would be most appropriate. This is because the FT 30 index is modelled on the Dow and has greater stability than the FTSE 100. Even so, there are differences between the FT 30 index and the Dow, which might mean there is greater specific stock risk in the FT 30 (for example, FT 30 stocks are only replaced if they are taken over or fail, whereas Dow stocks can be replaced by the editors of the Wall Street Journal).

Regarding the choice of low share price or low market capitalisation for the second filter, O'Higgins specifically states that the most relevant factor is "simply the phenomenon that the less expensive a stock is, the more it is prone to greater percentage moves." O'Higgins also believes UK companies are more prone to cutting their dividends in difficult periods compared to US companies and that this may mean a mechanical method based upon dividends would work less well in the UK.

Anyway, notwithstanding my gripes above about the padding in the book, the good parts are very good and the book carries an excellent central thesis: that simplicity not only entails less work, but also often produces better results.

By the end of the book I also understood why the method is likely to continue working. Historically the method did not work every year (for example during the last few years of the dot com boom), but produced good results over the long term. As O'Higgins states: "It's the occasional off-year that allows anomalies, like the strategies we'll be discussing next, to exist." The second, critical factor is that the method automatically enforces a contrarian discipline. I like the way O'Higgins puts it:

"In an investment world addicted to complexity, it can almost be said that keeping it simple is itself a form of contrarianism. It can certainly be said that for a system like mine to become too popular to work, contrarianism would have to become conventional wisdom. That would mean turning human nature on its head."

I have the book and have used the "High Yield 5" method since 1995. The results have beaten all other methods of investment that I have used and with the least amount of effort. I also enjoy the feeling of comfort involved with owning the various DJIA 30 stocks. Even if the share price drops, I know that in time it will recover! I'm convinced that in the long term, equities give the best return and that market timing is to risky and difficult. This method is so easy and the best news is that it works.

I know it sounds corny, but I feel that I found the pot at the end of the rainbow. I knew if there was some way that I could get the best of the Dow 30 that I could make money on a regular basis. But which ones? One day while my wife and I were at the library she hands me Beating The Dow, I read it that evening and I got my answer to "which ones". Without hesitation I started a portfolio and have stuck with the stratagy for several years. The book is easy to read and very informative. It gives a rundown on all the Dow stocks with easy to read charts and statistics. I wish this book was around 20 years ago. P.S. I purchased the book!