Time for a Change?
As the blue-chip average hits 10,000, should some of its members be replaced?
Barrons 4/05/99
By JAY PALMER
When the Dow Jones Industrial Average finally closed above the 10,000 level for the first time ever, a horde of pundits were inspired to issue all sorts of pronouncements about what levels the mighty Dow could reach in years and decades to come. An equally interesting question, and one of considerable importance to investors, is just what stocks in the years to come will be added to, or subtracted from, this bluest of blue-chip barometers. One thing is certain: Just as the Dow of today bears little resemblance to the 12 stocks that made up the original average back in 1896, so too the Dow of 2020 will look markedly different from the one we all track today.
Don't expect rapid change. History suggests that the Dow transforms itself slowly, with 10 stocks being added and 10 subtracted every quarter-century or so. We saw four additions in March 1997, when Travelers Group, Johnson & Johnson, Hewlett-Packard and Wal-Mart replaced Westinghouse, Bethlehem Steel, Texaco and Woolworth. Still, that doesn't rule out the possibility that there will be other changes over the next year or two.
The choice of just which stocks come in and out will affect the Dow's performance, perhaps in a big way. Does anyone doubt that if red-hot Microsoft had been added in back in '97, the Dow would have hit 10,000 months ago?
But which stocks should go in and which should be taken out? The sole responsibility for selecting the 30 stocks in the Dow belongs to the editors of our sister publication, The Wall Street Journal, so we at Barron's feel free to speculate on the changes that might be coming -- and to make a few suggestions.
Although the Dow is easily the world's best-known stock index and the recognized bellwether of both the U.S. stock market and the U.S. economy, critics contend that the average is too heavily weighted toward smokestack industries in a world that increasingly depends on services and technology, especially computers and the Internet.
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Hello 10,000! | Dow Candidates?
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Such criticism is off the mark, says John Prestbo, the Journal's markets editor and the chief keeper of the Dow. He points out that the Dow, despite having only 30 stocks, has behaved much like the Standard & Poor's 500 Index, which, as its name implies, consists of 500 stocks. On top of that, the argument can be made that the S&P 500 has moved ahead too fast to properly represent the economy or the overall stock market.
"We see the Dow as a metaphor for the market and the economy, not as a direct representation," Prestbo explains. "Certainly, no 30 shares can track a market perfectly, but this one comes close. Because of the kinds of companies in the Dow and their relationship with other companies, they end up representing the economy quite well. Is every sector represented? I believe so. Is every stock group? No way. But a lot of Dow stocks are related to others, and we feel we can achieve a much broader coverage with 30 companies than you might imagine."
When it comes time to add new companies, Prestbo has certain rules. "It has to be a large company, with a long track record, not just in terms of a large number of years but also in terms of performance through good and bad times. We don't like to see a lot of losses, and we do look for broad ownership and a wide following among investors." A steady stream of regular dividend payments, once crucial, is fading in importance.
Based on Prestbo's ground rules, a heck of a lot of stocks in the current Dow would seem to be candidates for expulsion. In fact, as the table shows, there are eight Dow issues with market values below $22 billion, which is just about the average value of each of the stocks in the S&P 500 Index. In the heady atmosphere of giant U.S. companies, $22 billion has become pretty small beer.
And just how widely followed are the likes of Union Carbide, Goodyear Tire, International Paper, Sears Roebuck and Eastman Kodak? Certainly it's a stretch to suggest that any of these companies are irreplaceable in representing today's economy.
What to add? Well, based on nothing more than market value, the companies in the table to the upper right of this page look promising. Each in its own way is a strong candidate. The main contender, though, has got to be Microsoft, not least because it is the world's largest company in terms of market value, but also because of the ever increasing importance of computers and software to our daily lives. Sure, IBM is big in software -- but it's no Microsoft.
That said, Microsoft has two possible strikes against it: 40% of its shares are owned by insiders, and its stock trades on the Nasdaq Stock Market, not the Big Board. Although one Nasdaq stock is included in the Dow Jones Transportation Index, up until now all stocks in the Dow Jones Industrial Average have been taken from the Big Board. However, Prestbo says Nasdaq membership is no barrier to entry into the Dow 30.
Intel is another large player that could be used to bolster the Dow's technology bias. Perhaps later on, America Online could be added to better reflect the growing importance of the Internet.
Either Pfizer or Bristol-Myers Squibb would be obvious choices to beef up the pharmaceutical sector, now represented by only Merck.
So, as you're toasting the Dow's first finish above 10,000, remember that these choices will help determine when, and whether, the Dow sinks to 8000 again, or surges ahead to 12,000. Our money's on Microsoft.
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