What A Changing Dow Means For Investors

David Sterman's picture

Tuesday, September 10, 2013 - 2:30pm

by David Sterman

We have Charles Martin Hall to thanks for many major industrial advances of the 20th century. His discovery of the process of aluminum smelting produced many breakthroughs in food services, packaging, automobiles and aerospace.

But Hall and the company he founded are no longer held in such high esteem on Wall Street.

Alcoa (NYSE: AA) has just been asked to pick up its things and leave the Dow Jones Industrial Average (DJIA). Hewlett-Packard (NYSE: HPQ) and Bank of America (NYSE: BAC) have also been shown the door.

I noted the possibility of these changes last year, predicting that Alcoa and HP were headed for the exits. I also thought Travelers (NYSE: TRV) would be given the boot, though the ongoing troubles at Bank of America made that financial services firm more vulnerable. The fact that BofA has more than five times the market value of Travelers was apparently of little concern. (And the fact that Travelers was added to the index only four years ago likely meant that it was too soon for a change of heart anyway.)

However, my predictions regarding which companies would join the Dow were off the mark. The addition of Visa (NYSE: V), Nike (NYSE: NKE) and Goldman Sachs (NYSE: GS) suggests a clear move to boost the Dow's global exposure -- but I remain stunned that Apple (Nasdaq: AAPL) is not yet a member of the Dow. A $450 billion market value and a $170 billion revenue base is pretty hard to ignore.

I'd add that Wells Fargo (NYSE: WFC), Berkshire Hathaway (NYSE: BRK) and Oracle (Nasdaq: ORCL) would have made worthwhile additions as well. They presumably remain on the short list when the Dow is again reshuffled in a few years.

What It Means For Investors
So how does the changing Dow affect investors? For starters, investors in exchange-traded funds (ETFs) that are based on the Dow, such as the SPDR Dow Jones Industrial Average (NYSE: DIA), now have incrementally better exposure to most dynamic aspects of the U.S. economy. (Despite its myriad industrial uses, aluminum is not an especially profitable business, and HP's computers are losing relevance.)

Companies that are added to the index can also see a quick share price boost (and the bragging rights don't hurt, either). Goldman Sachs, Visa and Nike all jumped 2% to 3% on news of their inclusion. The Dow rejects, on the other hand, didn't fall at a similar pace. Investors likely saw these exits coming.

What's next?
We can assume that this group will remain constant for at least a few years, unless any Dow components get merged out of existence. Recently, the Dow's strategists have tended to only make a cluster of changes every three to four years:

  • 1997: four companies replaced
  • 1999: four companies replaced
  • 2004: three companies replaced
  • 2008: three companies replaced
  • 2009: two companies replaced
  • 2012: one company replaced
  • 2013: three companies replaced
  • 2016: ???

Frankly, that's a lot of turnover in a 16-year stretch, reflective of the rapid changes taking place in the global economy. The newly constructed Dow shows a clear reflection of the kind of companies leading the global charge these days:

  • Five financial services firms: American Express (NYSE: AXP), Goldman Sachs, JPMorgan Chase (NYSE: JPM), Travelers, Visa
  • Five technology firms: Cisco Systems (Nasdaq: CSCO), Intel (Nasdaq: INTC), IBM (NYSE: IBM), and Microsoft (Nasdaq: MSFT).
  • Six industrial firms: 3M (NYSE: MMM), Boeing (NYSE: BA), Caterpillar (NYSE: CAT), DuPont (NYSE: DD), General Electric (NYSE: GE), and United Technologies (NYSE: UTX).
  • The remaining 14 firms are spread among the energy, telecom, consumer discretionary and health care sectors.

Action To Take --> There's no question that the Dow Jones Industrial Average just became a more relevant index for the U.S. economy. Yet the fact that Apple, Google (Nasdaq: GOOG) and Amazon.com (Nasdaq: AMZN) are all excluded means that the Dow planners have an outdated view of what drives the economy. 

Then again, investors can gain ample exposure to these firms through Nasdaq-focused ETFs. It's smart to make sure you have exposure to both the Dow and the Nasdaq for true long-term portfolio diversification. Is the Dow or Nasdaq a better investment for the near-term? Well, roughly a month ago, I made the case that mega-caps, including many companies residing in the Dow, hold relatively strong appeal right now.

P.S. -- The DJIA is select company, and only the strongest stocks are considered for inclusion -- but membership in our group of "Forever Stocks" is even more selective. We've spent six months and $1.3 million worth of research to find the 10 securities best suited for investors to buy, forget about and hold -- forever. To learn more about these stocks -- including some of their names and ticker symbols -- click here.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.