Anjali Cordeiro

Updated Sept. 7, 2006 12:01 a.m. ET

NEW YORK — Proponents of the Dogs of the Dow investment strategy say they have a lot to cheer about right now. The strategy, which is hinged partly on the hope that blue chips that did poorly in the preceding year will make a recovery, is proving to be a profitable one for 2006.

The Dogs of the Dow method involves investing in the 10 components of the Dow Jones Industrial Average with the highest dividend yield and holding those stocks for about a year. The dividend yield is calculated by dividing a company’s dividend by its stock price. So, many of the Dow components with the highest dividend yields have seen their share price decline during the preceding year, making them the supposed underdogs of the stock market.

By the end of August, the so-called Dogs had total returns of about 21% for 2006, according to data from Dow Jones Indexes. That was well above returns of about 7.9% from the industrial average as a whole.

At the end of last year, General Motors Corp. Verizon Communications Inc. and Merck & Co. were among the Dow industrials with the highest dividend yields, making them all Dogs of the Dow. All three stocks were beaten down sharply in 2005 for reasons related to their individual businesses or industries. Verizon lost roughly 26%, GM fell about 52%, while Merck declined a far more modest 1%. All three are bouncing back with vengeance this year. Verizon has gained about 18% so far in 2006, and Merck has added about 29%.

But GM’s stock is the most dramatic turnaround story among the Dogs. The automobile company’s stock has surged around 59% year to date, making it the best performing Dow industrial component for 2006.

Believers focus on the Dogs for a number of reasons. They are all large, dividend-paying companies we have all grown up with, said Neil Hennessy, president and portfolio manager of the Hennessy funds, a proponent of the Dogs of the Dow theory. You are getting paid to wait for the stock to go up in value.

Overall, the Dogs of the Dow theory tends to have an uneven performance. Last year, for instance, the 5% decline marked by the Dogs was worse than the returns of 1.7% from the industrial average as a whole.

Right now it’s a great strategy, but will it be five years from now? I don’t know, says Daniel Morgan, a portfolio manager at Synovus Investment Advisors. Market sentiment changes, leadership changes.