Dow Stock Basics
by Ethan Haskel ([email protected])
Baltimore, MD. (Oct. 14, 1998) -- In our last column, we explored the benefits of owning an extra handful of stocks of market-leading companies. It's these world-class corporations with high dividend yields that have consistently outperformed in all types of market conditions. The 30 stocks of the Dow Jones Industrial Average represent one collection of market-leaders, but surely there must be others out there somewhere.
What exactly are the characteristics of the Dow 30 stocks, and why do they work so well when applying the concept of high yield investing? First and foremost, they're big. Not simply big, but BIG. Large, huge, enormous, immense. Gigantic, mammoth, colossal, massive. (I've searched the thesaurus for other synonyms that are appropriate, but somehow "strapping" might not fit the bill here.)
In a word (or two, actually): size matters.
The Dow Dividend strategies work because the companies represented by the Dow 30 have the wherewithal, the enormous resources both human and financial, to weather most of the crises with which they're faced. Being so large, they're usually also surprisingly diversified; even if one aspect of their business hits a prolonged downturn, there are others that can keep them afloat. Philip Morris (NYSE: MO) derives about 43% of its revenues from sources besides tobacco. Even Exxon (NYSE: XON), synonymous with oil, received about 17% of its revenue from its chemical operations last year.
Smaller, less diversified companies just don't recover as easily when conditions turn. To quote James O'Shaughnessy (What Works on Wall Street), who has carefully analyzed many decades of returns of high-yielding stocks:
"The difference between the returns for high-yielding stocks based on market capitalization is huge. Investors who buy higher-yielding stocks should stick to large, better-known companies, which usually have the stronger balance sheets and longer operating histories that make higher dividends possible... Small stocks with high dividend yields may be in that position because their prices have fallen. Far from representing a bargain, their high dividend yields may be an indicator of more trouble to come."
When investing in high yielding stocks, bigger is definitely better. Is there anything else the editors of the Wall Street Journal look for in choosing companies to be included in the Dow 30? Diversity seems to be important; the corporations should represent a reasonable cross-section of the economy. The companies should be based in America. Finally, they cannot be primarily transportation companies or utilities, since these sectors are represented in separate Dow averages.
So, how best to reconstruct an alternate Dow 30? Let's find some really BIG American companies, assure a reasonable degree of sector diversification, and go to it. But first, we need a database. Next week we'll discuss the trials and tribulations of finding such a database. It's not as easy as you might think!
Year to date returns (as of 10-13-98):
Anheuser Busch +33.2% Emerson Electric +11.4% Ford +26.3% Kimberly-Clark -6.5% Texaco +15.9% Beating the S&P +16.1% S&P 500 +2.5%