Why the Dow Overshadows These Forgotten Stocks

Around the world, investors watch the Dow Jones Industrials (DJINDICES: ^DJI  ) as a measure not only of the 30 stocks in the average but also of the health of the entire global economy. Yet an obscure Dow average that few people even know about holds some interesting secrets about the broader stock market. Let's look at this forgotten benchmark to see what it can tell us about the current bull market.

Getting the bigger picture
What most people refer to as the Dow is known as the Dow Jones Industrial Average, but over time, it has come to include far more than pure industrial companies. With everything from technology and telecom stocks to consumer-goods and financials, the Dow includes nearly every sector of the economy.

Most people are aware that there are separate Dow averages for the transportation and utility sectors. Those averages have few components and are much more focused, lacking the outside influence that the Dow gives to companies beyond the industrial sector.

But what many people don't know is that there's an overall average, the Dow Jones Composite, that incorporates all three of the other Dow averages. If you want to include stocks from every part of the economy, then the Dow Composite is the place to go.

How has the Dow Composite done lately?
Like the Dow, the Dow Composite has risen to new record highs lately, having eclipsed the average's old 2007 highs earlier this year. But the Dow Composite has been setting new records for a lot longer than the Dow, as the Composite set a record on Jan. 25 and has risen more than 5% since then.

The strength in the composite has come largely from the transports. When you look at the best performers in the composite over the past year, the top five stocks on the list are all transports, with airlines representing the top four. Giants Delta Air Lines (NYSE: DAL  ) and United Continental (NYSE: UAL  ) have posted gains of 75% and 60% over the past year on the strength of higher ancillary revenue from baggage fees and similar charges, and the recent consolidation in the industry has boosted their prospects immensely. For top performer Alaska Air Group (NYSE: ALK  ) , up 82%, the possibility of further merger and acquisition activity has heightened interest in the regional carrier.

By contrast, the utilities have contributed the least to the Dow Composite's run. You have to go 13 deep into the top-performers list before you hit your first utility stock, NextEra Energy (NYSE: NEE  ) , which is up 31% after shifting its portfolio away from hydroelectric power toward wind and solar power that qualify for more tax credits. For the most part, utility stocks have lagged because of sluggish economic activity and the impact of costly natural disasters, particularly the two major East Coast hurricanes that hit the Northeast during 2011 and 2012.

Why don't people follow the Dow Composite?
If the Dow Composite is more complete than the Dow Industrials, then you have to wonder why the composite never gained in popularity. One reason has to do with the diversification within the Dow Industrials. Because the industrial focus of the Dow got watered down with the addition of non-industrial stocks to the average, combining the industrials with the transports and utilities leads to overweighting of the components from the two other Dow averages. Consider: The Dow Transports have 20 stocks and the Dow Utilities 15, but the Dow Industrials include only about five financial stocks, two energy stocks, and a similar small contingent from the rest of the sectors in the market.

Perhaps more importantly, the Dow Composite has tracked very closely with the Dow Industrials over time. Despite some periods during which performance differed in one direction of the other -- particularly the 1990s and early 2000s, when the Dow outperformed the composite before giving back ground during the financial crisis -- the Dow Composite doesn't add enough diversification to make it worth tracking instead of the Dow.

Still, the key lesson is to understand that the Dow is just one measure of the stock market. Looking more broadly beyond the Dow can give you additional insight that you won't get from looking solely at 30 blue-chip stocks.

If you're looking for some long-term investing ideas from the stocks in the Dow Jones Industrials, you're invited to check out The Motley Fool's brand-new special report, "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so simply click here now and get your copy today.


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