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1 year later: Buy stocks booted from the Dow?

Pras Subramanian

Around a year ago last September, the Dow Jones Industrial Average (^DJI) reshuffled the components of the index. It’s rarely done, as the committee prefers to keep the index fairly consistent over time. In this most recent move, Alcoa (AA), Bank of America (BAC) and Hewlett-Packard (HPQ) were replaced by Goldman Sachs (GS), Nike (NKE), and Visa (V).

As a disclaimer, Bank of America is a sponsor of Yahoo Finance Investing videos.

The last reshuffling before that was September 2012, when the then Kraft Foods (which split into Kraft Foods Group and Mondelez) was replaced by UnitedHealth Group (UNH). The last time before that was back in 2009, when in the wake of the financial crisis Citi (C) and General Motors (GM) were removed from the Dow.

As Nick Colas of ConvergEx Group notes in the attached video, these changes haven’t exactly worked out for the Dow. While the deletions - Alcoa, Bank of America, and HP - are up 50%, 9%, and 25% year-to-date respectively, the stocks added are up only 4% (Goldman), 13% (Nike), and -5% (Visa).

Since the Dow only has 30 components, the companies and weightings matter. According to Colas, only 5 stocks make up the gains for the Dow this year: Johnson & Johnson (JNJ), Disney (DIS), UnitedHealth (UNH), Merck (MRK), and Intel (INTC).

Colas believes the Dow committee has a tough job, relative to other indices. “Unlike the S&P 500 (^GSPC) where you have 500 names and a lot of chances to win, the Dow index is first of all price weighted, you have to be careful what you add in terms of price and then you have to be careful about not following momentum trades and this is a great example of where the committee probably dropped things at the wrong time and added things at the wrong time. It’s like active management, even though its like an index, or average.”

Despite it being almost anachronistic, the Dow holds some historical significance. “It does have one really important use that is it’s the only real-time index that we have back to pre-1900, it’s been alive and kicking all the way through the Great Depression, both world wars, into the recovery, even until today, one long continuous, published index.”

When the Dow does reconstitute itself, however, Colas believes there could be an opportunity for investors. “Like with all things as an investor, you have to be contrarian when somebody hates a name, [it's] probably a good time to buy. When someone like the Dow committee drops a name, time to look at it, and when something gets added, maybe the consensus trade is already in it.”

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