Get Ready for Dow 20,000
Up 13% so far this year, the Dow is outpacing both the S&P 500 and the Nasdaq. It could continue to outperform in the year ahead.
By Andrew Bary
Goldman’s Dow-leading 33% gain since the election has accounted for about a third of the index’s total advance. The Dow’s value is calculated based on the combined prices of all 30 stocks, multiplied by 6.85, giving outsize influence to the highest-priced shares.
The rally has helped restore some luster to the Dow, which trailed the S&P 500 in six of the seven years ending in 2015 and has been long eclipsed by the S&P as a benchmark for U.S. institutional investors.
“Even though money managers don’t use it much, the Dow remains familiar to the average person on the street. The majority of people know the companies in the index,” says Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
The Dow’s gain for the year has been led by Goldman Sachs, UnitedHealth Group (UNH), and Caterpillar(CAT), which together account for about 40% of the advance. One advantage of the Dow is a higher dividend yield, 2.4%, versus 2.1% for the S&P 500. All 30 Dow stocks pay dividends, compared with 418, or 84%, of the companies in the S&P.
Barron’s highlighted the allure of three Dow components— AppleAAPL in Your Value Your Change Short position (AAPL), Walt Disney (DIS), and Merck (MRK)—in our “Top 10 Stock Picks for 2017” article, which ran last week. Other Dow stocks look appealing, including American Express, IntelINTC in Your Value Your Change Short position (INTC), PfizerPFE in Your Value Your Change Short position (PFE), Travelers, and Verizon Communications (VZ). These five all trade for an undemanding 12 to 13 times projected 2017 earnings.
Some of the Dow’s 2017 laggards have gotten more appealing, including VisaV in Your Value Your Change Short position (V) and Home DepotHD in Your Value Your Change Short position (HD).
Visa, which is up just 2% this year, has one of the better growth outlooks among large-cap financials as it capitalizes on the continuing shift toward credit cards and electronic payments.
At $79, it trades for around 24 times projected earnings in its fiscal year ending in September.
Its expected annual profit growth in the next few years exceeds 15%.
Home Depot, also about flat this year, has seen its forward P/E contract to 18. With its leading position in home improvement, Home Depot still has a wide moat around its business that makes it more Amazon-resistant than most major retailers.
THE DOW REMAINS a quirky index that is structured like few others. Reflecting its origins in a paper-and-pencil era, the DJIA, as noted above, is calculated simply based on the stock prices of its 30 components. Each one-point change in a Dow stock results in a shift of 6.85 points in the index.
Goldman now is the most important company in the Dow because it trades at $241—even though, based on market value, it’s the 40th largest U.S. company.
The price weighting is one of the main knocks against the Dow. It means the world’s most valuable company, Apple (recent price: $113), is less influential than the Dow member with the lowest stock-market capitalization, Travelers ($119). Also, the lower-priced stocks in the index— Cisco SystemsCSCO in Your Value Your Change Short position (CSCO), Pfizer, General Electric (GE), Intel, and Coca-ColaKO in Your Value Your Change Short position (KO)—are largely irrelevant. GE would have to nearly triple to match the impact of Goldman on the Dow this year.
The Dow’s construction also means that a stock split—a relatively unimportant corporate event—can have a big impact. Visa went from being the index’s most important stock to an uninfluential member when it did a four-for-one split in 2015.
GE is the only component that dates to the original industrial average in 1896. Not surprisingly, the late-19th-century Dow index of 12 stocks featured industrial and commodity outfits that were then leaders of U.S. industry, including American Sugar, American Tobacco, National Lead, and U.S. Rubber.
The original index value stood at around 40, meaning the Dow has risen almost 500-fold in 120 years. It took until 1972 for it to hit 1,000 and then another 15 years for 2,000. The index passed 10,000 in 1999 and 15,000 in 2013. If 20,000 is reached by Christmas, it would be the quickest 1,000-point move in history—a month or less—although 1,000-point changes obviously mean less now than they once did.
AMONG THE CRITIQUES of the Dow is its technology deficiency. Its most important tech issue is International Business MachinesIBM in Your Value Your Change Short position (IBM), which has a larger impact than its other tech components—Cisco, Microsoft (MSFT), and Intel—combined. IBM has been a big negative for the Dow, as the stock has dramatically underperformed tech and the overall market in recent years. At $166, the stock is well below its 2013 high of $215. It also isn’t representative of many of the successful and value-creating tech innovations of the past decade, like social networking and online retailing, which are essentially unrepresented in the Dow.
The S&P 500, like most indexes, is weighted by the market value of its components. Only three of the seven largest issues in the S&P 500—Apple, Alphabet, Microsoft, Berkshire HathawayBRKA in Your Value Your Change Short position (BRK.B), Exxon Mobil (XOM), Amazon, and Facebook—are in the Dow. And none of the DJIA’s most important stocks—Goldman, 3MMMM in Your Value Your Change Short position (MMM), UnitedHealth, BoeingBA in Your Value Your Change Short position (BA) and Home Depot—crack the top 25 of the S&P 500 index.
Changes in the Dow happen infrequently, with the last shift occurring in 2015, when Apple was added and AT&T (T) was removed. That’s by design. “It should be more stable than the S&P 500,” says David Blitzer, head of the index committee at S&P Dow Jones Indices. “It consists of large, stable blue-chip companies that may not be flashy, but are reliable.”
“We spent a lot of time discussing that on the committee,” Blitzer says. “Everybody thought we should keep it the way it was.” He said a change from the current point-calculation method might confuse people. (The committee consists of three members from S&P and two from Barron’s sister publication, The Wall Street Journal.)
Still, the Dow’s configuration may have contributed to its waning influence. “When I started in the business 33 years ago, the Dow Jones Industrial Average was everything. It was the index that everyone tried to outperform,” says Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis.
“Now it’s gone completely by the wayside in the institutional arena. Even the retail community is not as focused on it.” One reason may be the growth of passive investing among individual investors. The main passive index is the S&P 500.
Paulsen adds that the Dow industrials haven’t reflected the growth in the technology sector in the past decade. Apple was added, but only in March 2015 after its stock had surged 20-fold in the prior decade.
Apple actually has fallen 10% since its addition. Because Dow changes are infrequent, companies are typically mature by the time they make the cut. The Dow guardians delayed adding Apple until a seven-for-one split cut its share price sufficiently to prevent it from overwhelming the other 29 stocks.
WHAT STOCKS COULD be the next additions?
Berkshire Hathaway and Facebook are obvious choices, with Comcast (CMCSA) another possibility. Berkshire’s less-exorbitant B shares, now around $164, could go into the index.
Low-priced stocks probably won’t be added because they can’t influence the index. The three stocks most vulnerable to deletion probably are Travelers, Cisco, and Intel. Travelers has the smallest market value in the index, while Cisco and Intel have low prices and are less important than they were a decade ago.
There have been five shifts in this decade including Apple’s addition. Goldman, Visa, and NikeNKE in Your Value Your Change Short position (NKE) replaced Bank of AmericaBAC in Your Value Your Change Short position (BAC), Hewlett-Packard,HPQ in Your Value Your Change Short position and Alcoa in 2013, and UnitedHealth replaced Kraft Foods in 2012.
Anachronistic, quirky, and derided as it may be, the DJIA has managed to stay relevant. And if industrial and financial companies thrive in the Trump era, the Dow’s popularity could rise again, as investors find new allure in an old index.
A resurgent Dow Jones Industrial Average is rapidly approaching the historic 20,000 mark, finishing Friday at 19,756 following another week of postelection gains that included its 23rd record close of 2016 and a 3.1% rise in the five sessions. The venerable index, which took its current form in 1896, now stands just over 1% away from 20,000 and could hit it soon.
The Dow industrials have risen 8% since Donald J. Trump’s surprise election victory on Nov. 8 and are up 13% for the year, topping both the Standard & Poor’s 500 index and the Nasdaq,NDAQ in Your Value Your Change Short position which have climbed 11% and 9%, respectively.
IT’S RARE TO SEE American Express—with its combination of a still-powerful brand, valuable payments network, and high returns—trading at a lower P/E than many banks. Pfizer has been down lately, along with the drug sector, and now yields almost 4%. Even with drug pricing pressure and an unspectacular product pipeline, Pfizer may be capable of mid- to high-single-digit annual earnings growth in the coming years. (The company was the subject of a favorable Nov. 30 article, “Pfizer: Easy to Swallow With Low P/E, 3.8% Yield,” on Barrons.com.)