-- BARRON'S: Is The Dow A Dog? Perennial Critics Say Yes, But The Index's Fans Say --
By Neil A. Martin
Three years ago the editors of The Wall Street Journal revised the Dow Jones
Industrial Average to bring the famous stock-market benchmark into step with the
evolving "new" economy. Their effort, for the most part, was successful. But
many investment professionals argue that the Dow is due for another revamping.
In November 1999 three old-economy smokestack issues -- Chevron, Goodyear and
Union Carbide -- and one old-line retailer, Sears, were excommunicated from the
30-company index, while retailer Home Depot, telecom SBC Communications and tech
heavyweights Microsoft and Intel joined the congregation.
While, for the most part, the investment community lauded the additions as a
needed update, the timing of the changes, just months before the collapse of
tech stocks in March 2000 -- was inauspicious. The shares of Microsoft, Intel
and SBC began slumping in early 2000, helping to drag down the price-weighted
index.
The Dow finished 2000 with a loss of 6.18%. In 2001 it fared worse, slipping
7.1%. And, as if to prove the adage that bad things come in three, especially
after the 9/11 terrorist attacks, the Wall Street benchmark has done even worse
this year, hitting a five-year low of 7,286.27 on Oct. 9. And despite a brief
rebound in following weeks, the index closed last Thursday at 8,432.61, off
15.85% since Jan. 1.
But it isn't the DJIA's dismal performance that has led some money managers,
Wall Street analysts and investors to conclude that it needs another update.
After all, the other market indicators are down, too, because most sectors of
the stock market have crumbled. The critics argue that, with just 30 stocks, the
more-than-century-old Dow is too narrow to truly reflect the market and that it
no longer is an "industrial" index -- regardless of how that term is defined
today -- because two-thirds of its weighting consists of telecom, high-tech and
financial-services companies.
"The index needs to decide what it wants to be -- an `industrial' index or a
services- or technology-based index," says Michael Kahn, a financial adviser and
technical analyst who writes a weekly column for Barron's Online.
John Prestbo, editor of Dow Jones Indexes and one of the chief keepers of the
Dow, has heard these arguments before. "We are always getting suggestions from
Wall Street, from the media and Monday-morning market watchers about what should
or should not be in the index," he says. "And there was lot of speculation this
past summer that we were going to make some changes. But we didn't do anything."
(Before we continue, some words of disclosure: The Dow and The Wall Street
Journal are both properties of Dow Jones & Co. , which also publishes Barron's.
However, we aren't privy to the deliberations of the Dow Industrials' guardians,
who, on this subject, tend to be as secretive as Saddam Hussein planning the
escape route he'll use when the first U.S. tank rumbles into Baghdad.)
Prestbo adds that "there are no specific quantitative rules about what goes in
or what goes out. We simply look at large, established companies with a certain
amount of track record and investor following that would justify their inclusion
in the index. And when we find one company vulnerable for removal, that forces
us to look at the other 29 components to make sure they are all working
together."
Naysayers assert that the Dow's managers tend to be more reactive than
proactive in making changes, replacing hammered-down companies with those
basking in glory but about to peak.
Michael B. O'Higgins, a Miami-based asset manager whose book "Beating the Dow"
is credited with popularizing the "Dogs of the Dow" investment theory in the
early 'Nineties, says that companies removed from the index typically do better
immediately thereafter than the new entrants.
That happened in the March 1997 face-lift, which saw Hewlett-Packard, Wal-Mart
Stores, Johnson & Johnson and Travelers Group (now part of Citigroup) replace
Westinghouse, Texaco, Bethlehem Steel and Woolworth. It also was true after the
November 1999 reshuffle, O'Higgins said when we interviewed him on Thursday.
"The four stocks they took out in 1999 currently are down 40%, while the stocks
they put in are down 45%. Including dividends, Sears is down only 9%, while its
replacement, Home Depot, is down 53%." Still, the Industrial Average has many
defenders, not least because it's so well-known. "Don't forget the psychological
impact of the Dow on investors worldwide," says Andy Addison, an investment
adviser based in Franklin, Mass. "It may not be the most reliable guide to
finding out what the market's true vital signs are, but it is undeniably the
most widely watched, tracked and analyzed. Hence, it is not only important, but
relevant."
It will become even more relevant if Congress, as seems likely, ends or
reduces the taxation of dividends that investors receive. Currently,
corporations are taxed on the earnings that finance dividend payments, and those
dividends themselves are taxed after investors receive them.
"If we do get the repeal of double taxation of dividends, you'll probably see
people looking at the Dow components more closely than before simply because
most of the companies represented in the index not only have the wherewithal to
pay them but increase them as well," says Phil Dow (yes, that's his name),
director of equity strategy at Minnesota-based RBC Dain Rauscher. "My guess is
that with the ongoing shift of investor focus to value and financial stability,
the Dow will become even more relevant in the years ahead."
The DJIA's supporters say investors would pay even more attention to the index
if its lineup were shaken up to reflect current realities.
At the top of most market watchers' hit list is AT&T. "It is a very different
company today from what it was five years ago," says Peter D. Green, chief
technical analyst at MKM Partners, an institutional brokerage firm in Greenwich,
Conn. "Its market cap is smaller than SBC Communications' and, although it is in
better shape than some of its rivals, the company faces an uphill battle to
shore up its balance sheet and restore investor confidence."
The company recently spun off its AT&T Broadband unit, which was merged into
Comcast, and completed a 1-for-5 reverse stock split -- a desperate measure
aimed at shoring up its battered share price. At its recent, split-adjusted
price of 27, AT&T was down 27% since the start of the year.
"Reverse splits are basically gimmicks to pump a stock quote and rarely work.
This was not a good sign for AT&T," says Green, who would replace beaten-up Ma
Bell with AOL Time Warner, which also has monumental problems but is almost
three times AT&T's size. "AOL is a fully integrated media company with global
interests and a good replacement if you're looking for something in the
communications sector," Green says. At a recent 13.18, AOL's stock price was
down almost 59% this year, hurt greatly by the woes of its America Online unit.
But it's a good recovery candidate, Green maintains.
The MKM Partners analyst also would replace J.P. Morgan Chase with insurer
American International Group. He favors AIG because of its huge market cap ($155
billion), dominance of the multiline- coverage sector and growing presence in
Asia, especially in China. "AIG will be a chief beneficiary of China's future
expansion," he says. J.P. Morgan late last week was quoted at 24 and change, 41%
below its 52-week high and down by more than 32% on the year.
Green contends that Bank of America should join the Dow because of its growing
and profitable Asian business, its size (about twice that of J.P. Morgan) and
relative strength in global financial services. The bank's common has been
trading around 70, about 9% off its 52-week high, and has room to grow, Green
asserts.
Other analysts and fund managers point to International Paper, Alcoa and
Caterpillar as candidates for removal from the Dow roster. Their argument: These
old-line companies' prospects over the next few years are uncertain or, at best,
limited.
Jim Huguet, co-CEO of Great Companies, a Clearwater, Fla., investment-advisory
concern that manages $500 million in large-cap mutual funds, recently charted
the performance of the Dow Jones Industrial Average over one-, three-, five- and
10-year periods. He replaced Dow stalwarts AT&T, Honeywell, Merck,
Hewlett-Packard and Eastman Kodak with his recommendations -- AIG, Medtronic,
Dell, Omnicom and Pfizer, companies he says have done better in the past than
the DJIA and that he thinks will do better in the future, too.
Using Nov. 30 closing prices, Huguet's reconstructed Dow outpaced the real
Industrials significantly in all but a one-year span.
For the year, his index fell 10.3%, versus the actual Dow's 9.2% decline. Over
three years, his index was down 13.85%, compared with the DJIA's slide of 19.3%.
Over five years, his index was up 39.8%, while the Industrials gained 21.4%. And
over 10 years, the reconstituted Dow had a whopping 514.8% advance, compared
with 297.6% for the real average.
Huguet says his theory has been borne out by the performance of his 30-stock
IDEX Great Companies American Fund, which has seven Dow components -- Procter &
Gamble, 3M, Johnson & Johnson, General Electric, Coca-Cola, United Technologies
and Citigroup. Through last Thursday, the stocks in Huguet's portfolio were down
6.38% this year, versus the Dow's 15.85% decline.
(MORE) Dow Jones Newswires
12-27-02 2251ET- - 10 51 PM EST 12-27-02
Symbols:
US;AA US;AIG US;AOL US;BAC US;CAT US;DD US;DELL US;DJ US;EK US;GE US;GM US;HON
US;IP US;JPM US;KO US;MDT US;MMM US;MO US;PFE US;PG US;SBC US;T US;UTX DE;AOL
DE;AOLF DE;AOLX XE;AOL DE;AOLS CA;BACC CH;CAT DE;CAT FR;CATR GB;CTA PE;CT
XE;DELL CA;GM CH;KO DE;CCC GB;CCA PE;KO XE;KO CA;PFEZ CA;SBCY CH;SBC DE;SOB
NL;SBC CA;ATNT
28-Dec-2002 03:51:00 GMT
Source BAR - Barron's |
