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In an article last week, I identified three companies currently included in the Dow Jones Industrial Average (INDEX: ^DJI ) that I thought had reason to be removed. The index has been changed on only 48 occasions since it began in 1896, and changes are done only on an as-needed basis. When a company is removed, it's generally when there is a fundamental change in either the company's business or the economy at large -- such as when Eastman Kodak failed to adapt its business model to digital photography and therefore stopped being as relevant a force in the U.S. economy as it once was.
So to figure out how to replace those three stocks, I began my search by examining the companies of the S&P 500 index, because these companies are followed by a lot of investors. Since the current components of the Dow all pay a dividend, I eliminated the companies that do not currently pay one. As I sought companies that lived up to the Dow Jones' standards of "an excellent reputation, demonstrated sustained growth, and ... of interest to a large number of investors," I didn't only look at companies in the same sectors as the ones I replaced -- although, as it turned out, two of the three companies I selected came from those sectors.
A bank with our country's name
To replace struggling Bank of America (NYSE: BAC ) , I tapped another large bank from Warren Buffett's holdings. Although Berkshire Hathaway didn't add to its position recently, US Bancorp (NYSE: USB ) remains a Buffett favorite and currently makes up a sizable portion of the Berkshire investment portfolio. In the colorful words of Charlie Munger, US Bancorp tends to "avoid stupidity better than most" banks.
Based on market cap, US Bancorp is relatively close to its once-proud rival and is the 10th largest bank holding company in the United States by total assets. It's based in Minneapolis, away from the other large banks, most of which are located in New York. Unlike Bank of America, US Bancorp stayed profitable throughout the financial crisis and currently yields almost 2%, compared with Bank of America's paltry 0.7%. Although it received money as part of the Troubled Asset Relief Plan in 2008, US Bancorp was among the first banks to repay the funds, doing so in January 2009. Because of all these factors, I think US Bancorp would be a welcome addition to the Dow.
A more diversified metal producer
Aluminum producer Alcoa's (NYSE: AA ) best days may be behind it, so I tried to find a company that better reflects the future of metals, both in this country and abroad. The company I settled on is copper miner Freeport-McMoRan Copper & Gold (NYSE: FCX ) , a favorite of our analyst Jim Mueller. Even though the company is currently dealing with workers' strikes in overseas mines, the long-term trend toward rising copper prices gives the company a chance to be really successful should it get its labor issues under control.
As its name suggests, Freeport doesn't just produce copper. It also mines gold and silver, broadening its precious-metals coverage. This makes Freeport more attractive than single-commodity-focused Alcoa, allowing investors to get a nice exposure to various metals through one company. Furthermore, compared with Alcoa, it's cheaper based on P/E, has a higher yield, and is nearly four times the size based on market cap. Finally, even though its recent returns have been less than stellar, it has outperformed Alcoa substantially over the past 10 years. With China leading the way in copper consumption, the sky's the limit for this multi-metal producer, making it a great potential addition to the Dow.
Oil rules the world
Failing to find a suitable technology company to replace Hewlett-Packard (NYSE: HPQ ) , I decided to add what the Fortune 500 ranks as the fourth-largest company in the nation. Since we Americans consume a lot of oil, it's no surprise that ConocoPhillips (NYSE: COP ) is that company, and it would join ExxonMobil and Chevron on the Dow. As with most oil companies today, ConocoPhillips produces a lot of natural gas, ranking as the seventh-largest gas producer in the United States.
Following the example of other oil companies, ConocoPhillips is planning on spinning off its refining business in 2012. Whether this will be enough to make it the perfect stock will be hard to gauge right away, but it may lead the other big oil companies to follow suit. Although it would fall in the lower half of the Dow 30 based on market cap if it were added to the average today, it would have the sixth-largest dividend of the Dow companies if it remains around its current yield of 3.7%. With oil still such a valuable commodity, and with its exposure to natural gas, ConocoPhillips seems poised for great things as a possible addition to the Dow.
What it all means
Nobody outside the folks at Dow Jones know whether a change is coming to its most widely followed index, or when such a change might occur. I could be way off or partially right. Only time will tell. What do you think? Am I missing some great companies that would be better suited for the Dow Jones Industrial Average? Are there different companies currently on the Dow that would be first to go in the event of a shakeup? Let me know in the comments section below!