AT&T (TFree AT&T Stock Report) and Verizon (VZFree Verizon Stock Report) have a lot in common. For starters, as the Business Description of bothUsing the VL Page_Business Disc companies notes, they are telecommunications companies with a material focus on cellular service. A little over 50% AT&T’s 2011 revenues came from cellular, while just over 60% came from that source for Verizon. Basically, these companies are the largest cellular operators in the United States.

Looking at the dividend yields of these two telecom giants reveals a similar picture. AT&T’s yield was recently 5.1%, while Verizon’s was 4.7% (found in the Top Label that runs across the top of each report). Moreover, each has been increasing its distributions on an annual basis of late. That said, AT&T’s history of annual dividend increases is much more impressive than Verizon’s, which kept a static $1.54 per share annual dividend between 1998 and 2004, and $1.62 in 2003 and 2004. Since 2004, however, annual increases have been the norm. AT&T, meanwhile, has increased its distribution every calendar year shown in the historical portion of the Statistical Array (which currently goes back to 1996).

The dividend and business focus of these two Dow Jones Industrial Average components presents an interesting issue. They are both so-called Dogs of the Dow, since their high yields place them within the top ten highest yielding companies in the Dow 30. That’s well and good, but that means that two telecom companies are part of the total of 10 companies that make up the Dogs list. That means 20% of an investor’s assets are in telecom if he or she religiously follows the Dogs of the Dow methodology. That’s clearly a lot of exposure to one sector.

To make matters worse, both companies are trading at or near 52-week highs. The high and low prices for each calendar year are shown above the Graph. InUsing the VL Page_Graph fact, both are trading at levels they haven’t seen since 2008. The relative price chart (the dotted line at the bottom of the Graph) clearly shows that both have been performing better than other stocks of late. The trailing cumulative return figures (shown to the right of the Graph) show this same thing in a different way, with each company outperforming the broader market by a wide margin over the trailing Using the VL Page_Timeliness Ranks Box12 months through May.   

 In further support of the similarities, Value Line’s proprietary Ratings and Ranks are close to identical for each company. Each has a Timeliness Rank of 2 (Above Average), a Safety Rank of 1 (Highest), and a Technical Rank of 3 (Average)—each of these is found in the Ranks box. Moreover, each has a Financial Strength rating of A++ (the best awarded) and a Price Stability score of 100 (also the best awarded)—these are found in the Ratings box. Their scores for Growth Persistence and Earnings Predictability are close, as well.

Using the VL Page_Annual Rates Box The outlook for each company is also very similar, too, with analysts Justin Hellman and Kenneth Nugent projecting revenue growth and dividend growth in the low single digits over the next three to five years. Earnings growth, meanwhile, is projected to be in the mid-single digits for both. These figures can be found in the Annual Rates box.

Trading systems are meant to be followed closely. Making alterations to a system’s recommendations means that an investor’s results will not match those of the system, which can be a good thing or a bad thing. Clearly, however, having 20% of assets in two roughly similar telecom companies would seem to be a problem from the old recommendation of not putting all of your eggs in one basket. That said, both have been powering the Dogs strategy’s return of late.

It is also worth noting that telecom isn’t the only problem area in the Dogs strategy of late. Pharmaceuticals giants Merck (MRKFree Merck Stock Report) and Pfizer (PFEFree Pfizer Stock Report) are also in the Dogs. So, too, is Johnson & Johnson (JNJFree Johnson & Johnson Stock Report), but that company is more diversified than Merck or Pfizer. This diversification problem clearly isn’t unique to the telecom industry.

The call of veering away from the Dogs method is up to the individual, and once such a shift starts, it could snowball quickly. There are different ways one mightUsing the VL Page_Top Label lighten the exposure to a single industry. Selling out of a one of several similar companies is the quickest way to lighten the exposure to an industry. On this front, note that Verizon’s P/E relative to that of the broader market (1.20) is materially higher than AT&T’s (1.02); these figures are found in the Top Label. Note that both relative P/Es are higher than their historical norms.

One might also sell portions of each company, keeping their weighting in line with each other, while still raising cash and lightening the overall exposure to a single industry. This might be the better option, as it would lock in gains, reduce the risk of a large overweighting in one industry, and still maintain the recommended stock holdings, which reduces company specific risk.

The cash could be allowed to sit, awaiting reinvestment on the first trading day in January 2013, or invested in the 11th highest dividend yielding company in the Dow Jones Industrial Average. Neither option is in keeping with the rules of the Dogs of the Dow strategy. Another option would be to simply go far afield and purchase an income producing equity from outside the Dow or shares in a dividend focused mutual fund or exchange traded fund. It should be obvious by now that straying from the method gets complicated fast, which makes the decision that much more difficult.

It’s impossible to offer specific advice to individual investors because of the varied life situations everyone faces. Still, it is important to realize the difficulties inherent to whatever investment approach you might have chosen. The Dogs of the Dow is simple, but in that simplicity lies complication of another sort. If you religiously follow the Dogs method, you should probably leave well enough alone. However, you should be well aware of the fact that your portfolio is overweighted in telecom and drug stocks. If you loosely follow the Dogs, you should consider doing something about those overweightings.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.