How to Fix the Dow – 3 Stocks to Drop & 3 to Add

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May 26 marks 115th birthday of the much-followed — and much maligned — Dow Jones Industrial Average. Charles Dow created the benchmark on May 26, 1896, at a reading of 40 points, representing the dollar average of 12 stocks from leading U.S. industries.

There have been a host of changes to the index over the years, with the lineup of component stocks growing to 30 and involving 48 different formulations since its inception. The index is referred to as an “industrial” average largely out of historical deference, and the modern makeup is meant to reflect the diversity of the American economy.

Some of the most recent changes include Kraft Foods (NYSE: KFT), Cisco (NASDAQ: CSCO) and Travelers (NYSE: TRV) that replaced victims of the financial crisis General Motors (NYSE: GM), American International Group (NYSE: AIG) and Citigroup (NYSE: C).

But why wait until a company goes bankrupt or gets bailed out to rejigger the index? If the Dow is so widely cited by the media and economic analysts, shouldn’t it be a precise gauge of the stock market and the American economy as a whole — and not just a nostalgic list of old giants that have seen better days?

There’s a lot that goes into building an index, and a list of just 30 stocks is always going to have its flaws. But on the Dow’s 115th birthday, allow me to offer my humble suggestions on how to improve the index by kicking out these three stocks and adding three new components.

Dow Drop #1: Cisco

cisco logo csco HOMEPAGEI’m not just projecting frustration at Cisco (NASDAQ: CSCO) because of this dead tech stock’s performance over the last few years. But Cisco, unfortunately, exhibits one of the worst characteristics about newcomers to the Dow — namely, the fact that joining the Dow is the kiss of death for a blue chip stock.

Why should we suffer an underperforming tech stock when there are plenty of older, more attractive alternatives already part of the index? Hewlett-Packard (NYSE: HPQ), Microsoft (NASDAQ: MSFT), IBM (NYSE: IBM) seem to have corporate technology well-covered. We don’t need four such companies – and as the new kid on the block, Cisco is the one that should be shown the door.

Dow Add #1: Apple

AppleWhile all these tech stocks crowd the corporate market, in the current makeup of the Dow Jones Industrial Average, there are no true consumer technology plays. So why not add the 900-pound gorilla of consumer tech, Apple Inc. (NASDAQ: AAPL)?

The closest would be Intel (NASDAQ: INTC), but the semiconductor giant serves so many chip markets it isn’t a pure play on consumer tech. What’s more, in addition to adding consumer technology to the footprint of the Dow, adding Apple would toss in one of the largest corporations in the world — a move that is long overdue according to many market watchers. The downside, of course, is that since the Dow is a price-weighted index rather than market cap-weighted, Apple would instantly have the most pull at $350 a share and could really move the index. (Read a column from Jon Markman about how adding Apple would boost the Dow). But considering Apple’s strong upwards momentum, many folks may not complain too much about that influence in the near future.

Dow Drop #2: Verizon

Verizon Communications (NYSE: VZ)It’ a bit baffling to think why Verizon (NYSE: VZ) and AT&T (NYSE: T) are both in the index these days. Even before wireless carrier consolidation in the 2000s that didn’t figure, and now that the telecom pool is largely filled by two fish — with #3 Sprint (NYSE S) failing to turn a profit since early 2007 and T-Mobile about to be swallowed whole — it makes even less sense. Verizon and AT&T are little more than utility stocks with reliable revenue streams, approaching a legalized duopoly. AT&T is the older component, so it can stay while VZ gets the axe.

Dow Add #2: Amazon

AmazonJust Apple corrects the lack of consumer technology in the index, Amazon.com (NASDAQ: AMZN) acknowledges the importance of retail — and specifically, e-commerce.  The only true retailer among the Dow 30 components is Walmart (NYSE: WMT), though you could argue a case that Home Depot is a retailer, too. Considering the power of American consumer spending in the overall makeup of the economy, it seems that retail should play a bigger role. What’s more, with a market capitalization of $88 billion — the equivalent of Target (NYSE: TGT), Sears (NYSE: SHLD) and Costco (NYSE: COST) combined — it dwarfs other retail alternatives.

Dow Drop #3: Pfizer

Pfizer (NYSE: PFE)The same argument against Verizon is the argument I will make for nixing Pfizer (NYSE: PFE) — why do we need to pharmaceutical stocks? Health care is an important industry, but important enough to have two companies focused on pharmaceuticals in the index. Merck (NYSE: MRK) is a slightly smaller company but has been in index since the 1970s so deserves to stay. What’s more, Johnson & Johnson (NYSE: JNJ) has limited pharmaceutical operations on top of its strong consumer health care products like Band-Aids and Tylenol. Considering patent expirations and generic drug competition are loosening the stranglehold some of the Big Pharma heavyweights had on prescription drug sales, the Dow should loosen its grip on the sector, too.

Dow Add #3: Monsanto

MonsantoThe agricultural industry may sound like a quaint throwback to 1896 when the Dow was first born. But as my old boss Louis Navellier used to say, what Saudia Arabia is to oil, America is to corn and soybeans. That’s where Monsanto (NYSE: MON) comes in. Its Roundup Ready seeds and related herbicide are the gold standard of farms across the U.S. As a result, rising demand for crops means rising demand for Monsanto products. Similarly, soft commodity prices and reduced farm activity means MON stock will suffer in kind. It’s a great benchmark for agribusiness, a sector the Dow should include. And though Monsanto isn’t a behemoth like some of the $100 billion-plus stocks in the Dow lineup, it is twice the size of current component Alcoa (NYSE: AA) and about 50% larger than recent addition Travelers (NYSE: TRV).

What do you think about these changes? What would you kill and what would you add if you were in charge of the Dow? Share your thoughts in the comment section below!

Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks named here. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.


Article printed from InvestorPlace Media, https://investorplace.com/2011/05/dow-jones-industrial-average-vz-csco-mrk-pfe-aapl-mon/.

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