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The Dow Jones Industrials (INDEX: ^DJI ) go far beyond industrial stocks. Among its ranks, you'll find technology and telecom companies, consumer and financial stocks, and health-care and materials businesses alongside true industrials.
But even though the Dow does a good job of being a fairly representative sample of the U.S. stock market, there are a few areas where it does an inadequate job covering the field. Let's identify some of those missing areas and then search for some companies that might fill the void.
First and foremost, it's important to note that the Dow was designed to exclude two important sectors of the market: transportation stocks and utilities. These two categories have Dow averages of their own, so putting them into the Dow Industrials would introduce redundancies that would transform the relationship among the three averages.
Still, there's one area that has historically blurred the line: vehicle production. Until shortly before its collapse during the financial crisis, General Motors had a long-held place among the Dow 30. Given GM's still-substantial ownership by the U.S. and Canadian governments, it's unlikely to rejoin the Dow anytime soon. But Ford (NYSE: F ) has weathered the economic storm very well, regaining its investment-grade bond rating and starting to pay a reasonable dividend. Skeptics will scoff that its share price around $10 would make it insignificant for Dow calculation purposes, but for the Dow to return to its old-economy roots, letting Ford in would plug up the hole left by GM's departure.
The growth in health care
The Dow also has some sectors where there's plenty of representation, but the companies selected don't cover the entire universe of subsectors within that sector. One example is health care, where you have fairly broad coverage of pharmaceuticals, medical devices, and consumer health products.
But the missing piece of the puzzle is biotech. Increasingly, biotech stocks have been the growth drivers in the health-care industry, as older pharmaceutical companies struggle to build up pipelines of traditional drugs that can replace aging blockbusters that have gone or are slated to go off-patent. In many cases, Big Pharma has simply bought pipelines from promising small biotechs, while others have formed partnerships with some of the larger companies.
Among biotechs, Amgen (Nasdaq: AMGN ) is arguably the logical choice to join the Dow. It has the largest market cap, and it recently became the first major biotech stock to pay a dividend, with a current yield of about 2%. Unlike Ford, Amgen's share price presents no problems for Dow weighting purposes. Given that biotech companies have become mainstream giants that turned what was a niche area into huge success, the subsector deserves a place on the Dow, and Amgen would make a worthy representative.
Recognizing the Internet
The Dow has always been a bit slow to adopt new technology. Although IBM has been in the average for decades, most of the current tech members of the Dow are relatively recent entrants to the benchmark. And while many of them have tied their fortunes to the Internet over time, what you won't find are stocks whose success came from the Internet.
Several different subclasses of Internet stocks present promising candidates. Amazon.com has become a leading retailer not just compared with online peers but with the retail industry in general, and its ongoing innovation in hardware, virtual computing, and other technological advancements have helped give it its $100 billion market cap. Meanwhile, eBay (Nasdaq: EBAY ) has a market cap only half as large as Amazon, but it has found its own retail niche through its auction site, as well as being at the forefront of advancements in electronic and mobile payments.
One could even make a case for having Facebook (Nasdaq: FB ) join the Dow at some point. Forget its disastrous IPO and instead focus on its leading role in the new social-media space. Although Facebook has far too short a history to expect it to become a Dow component in the near future, social media could become a Dow-worthy enterprise if Facebook can find a way to effectively create a stream of rising profits from it.
What the Dow offers now
Even though the Dow leaves out some promising stocks, what it does include still gives you plenty of good investing prospects. Be sure to read The Motley Fool's brand-new special report, "The 3 Dow Stocks Dividend Investors Need," and learn how some of the Dow's healthiest dividend-rich growth prospects give you the best of all worlds. Grab your free copy today.