The New Dow Jones Industrials: Good, Bad, or Sleight of Hand?

Written by GSCR Staff   
Tuesday, 10 September 2013 23:19

The big news on Wall Street yesterday was the subtraction and addition in the Dow Jones (30) Industrials.  This is the first change in the index since 2004 and marks the exit of Alcoa (NYSE – AA), a part of the Dow for over 50 years.

The change will take place Monday morning September 23rd as Goldman Sachs (NYSE – GS), Nike (NYSE – NKE), and Visa (NYSE – V) replace Alcoa, Bank of America (NYSE – BAC), and Hewlett-Packard (NYSE – HPQ).

This topic is right on cue from this week’s Goldman Guide as one of our points centered on stock indices and weighting.  The Dow Jones is a priced=based index and from strictly that perspective it is easy to see why these stocks were replaced.  Here is a brief summary from a quick glance intraday yesterday with rounded percentage and dollar figures.

IN

GS: $165, Up + 21% YTD, Financials

NKE: $66, Up +26% YTD, Consumer Goods

V: $184, Up +15% YTD, Financials

OUT

BAC: $15, Up +20% YTD, Financials

AA: $8, Down -10% YTD, Materials

HPQ: $22, Up +48% YTD, Technology

Here is some quick math.  The “IN” stocks equal $415 total, and the “OUT” stocks equal $45 total.  This is almost a 10x multiple.  As far as average YTD returns are considered, it is pretty much a wash with IN equal to about 20% and OUT equal to about 19%, with HPQ skyrocketing in 2013 and AA on the slide in a bull market.

The sector changes are somewhat telling.  GS, a high-end brokerage and V combine to replace BAC in my opinion.  A direct sign of where the average consumer is related to finances.  AAPL replaced HPQ a long time ago!  Finally, NKE replacing AA can be yet another indication of the declining manufacturing base in the US being replaced by a consumption driven trade-deficit economy and growth/brand name migration.

For the conspiracy theorists out there, I offer this nugget.  Have you ever considered how many products are sold that are passive index ETF or mutual funds tied to the Dow Index?  I am not saying this is what occurred here, but clearly there is a lot of money to be made in retail investing, and replacing has-beens with hipsters from a public perception standpoint can only aid in the sales pitch. Moreover, this change will leave an indelible mark on P/E valuations as they will be higher now than they have been previously which may skew one’s perception of undervalued or overvalued.

Finally, David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices stated, “There’s no intention to pick winner”.  Along those lines an outstanding article was written in MarketWatch yesterday with the link below.

http://www.marketwatch.com/story/getting-booted-from-dow-a-blessing-2013-09-10

Here is a quick glance at a composite analyst score (the higher the better) and forward 12-month P/E (the lower the better) from a few sites.

IN

GS: Score = 2.7, Forward P/E = 11

NKE: Score = 2.3, Forward P/E = 19

V: Score = 2.1, Forward P/E = 21

OUT

BAC: Score = 2.7, Forward P/E = 11

AA: Score = 3.0, Forward P/E = 16

HPQ: Score = 2.8, Forward P/E = 6

Getting out of the DJ Index just might be the ticket.

Have a great day!

Disclosure: Goldman Small Cap Research analysts are neither long nor short these shares but may elect to purchase the stock within the next 48 hours.

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