The 5 Riskiest Stocks in the Dow

Most investors see the Dow Jones Industrials (DJINDICES: ^DJI  ) as among the safest blue-chip stocks in the entire market. But some of the Dow's 30 components are riskier than others, and just because a stock is in the Dow doesn't mean that it's invulnerable to market reversals. Own the wrong stocks when the market starts to decline, and you could magnify your losses.

One way of measuring the risk of a stock is by looking at its share-price volatility. Using a metric called beta, you can see which stocks have had the biggest rises and falls in response to changing market conditions in the past. By that measure, let's look at the five riskiest Dow stocks over the past five years.

Bank of America (NYSE: BAC  ) , beta = 2.40
The fact that Bank of America tops the list of riskiest Dow stocks should come as no surprise. B of A was one of the hardest-hit banks during the financial crisis, as its buyouts of Countrywide and Merrill Lynch greatly heightened the risks it had already taken in its own core banking operations. Even now, the bank has a leverage ratio of 9.3, which is more than many of its domestic traditional-banking peers.

Still, B of A has taken many steps to get less risky in recent years. Passing the Federal Reserve's stress tests earlier this month shows how far B of A has come, and even with $5 billion in share buybacks coming, the bank's decision not to increase its dividend will leave Bank of America in a more stable capital position as it continues to earn profits and bolster its balance sheet.

Alcoa (NYSE: AA  ) , beta = 2.10
The commodity space has always been risky, as business cycles push various commodities in and out of favor. Aluminum has been one of the most volatile of commodities in recent years, as changing global economic conditions in the construction and infrastructure industries have sent industrial metals rising and falling sharply. With major Chinese aluminum producers getting subsidies to boost production despite low prices, Alcoa suffers the consequences of a glut of supply on the global market.

Still, Alcoa has taken steps to maximize its eventual benefit when the business cycle turns higher. Seeking strategic acquisitions and looking to build partnerships with China, Alcoa could turn its woes into greater profits when the tide turns.

Caterpillar (NYSE: CAT  ) , beta = 1.91
Caterpillar is similarly exposed to world economic conditions. As the giant in the construction-equipment industry, Caterpillar needs healthy economies around the globe to support its business. Yet lately, higher competition and weaker activity levels, especially in China, have hurt the company. As far out as 2015, Caterpillar remains skeptical of its ability to grow to its maximum potential.

Still, because of Caterpillar's global breadth, it may be able to avoid the full brunt of a stock-market downturn if that downturn is caused by domestic considerations. Caterpillar does do substantial business within the U.S., but the benefit of global diversification can help in anything short of a global stock-market collapse.

American Express, beta = 1.80
American Express had to deal with the recession and financial crisis in much the same way as regular banks. With credit risk from its charge cards and falling transaction volumes during the economic slowdown, AmEx is tightly connected to the health of the economy.

Yet AmEx is doing its best to broaden its appeal beyond its traditional core base of wealthy customers. Its Bluebird prepaid debit-card initiative is aimed squarely at lower-income customers, with the capacity to generate brand new revenue and get its products in front of new faces. Prepaid cards are a highly competitive business right now, so AmEx still has plenty of risk, but it has a strong brand behind it in its drive for success.

General Electric (NYSE: GE  ) , beta = 1.63
General Electric was another near-casualty of the financial crisis, with the conglomerate's GE Capital overwhelming GE's traditional core industrial business. Since then, though, the company has bounced back by returning to its roots and moving forward in lucrative directions, including energy infrastructure.

In some ways, having a purer industrial focus leaves GE more vulnerable to the cyclical nature of its business. But given GE's success even in a relatively unfriendly environment for industrial stocks worldwide, faster global growth could make the stock truly soar.

Use caution
One thing to be aware of in considering these stocks is that beta is a backward-looking measure. Although it's reasonable to assume that stocks that have been risky in the past will continue to be risky in the future, that's not an ironclad certainty looking forward. Nevertheless, being aware of the risks involved in every stock will leave you better prepared to handle inevitable future market downturns.

Risky or not, Bank of America’s stock doubled in 2012. Is there more yet to come? With significant challenges still ahead, it’s critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool’s premium research report on B of A, analysts Anand Chokkavelu, CFA, and Matt Koppenheffer, financials bureau chief, lift the veil on the bank's operations, including detailing three reasons to buy and three reasons to sell. Click here now to claim your copy.


Read/Post Comments (6) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 24, 2013, at 10:44 AM, taplinger wrote:

    You talk about GE's recent success, but that's relative - from $58 to $23.50 is very relative. It was $40 before the crash.

    In more objective terms, GE investors since the crash have had terrific success in bottom fishing. GE's success has been in producing bottom feeders.

  • Report this Comment On March 24, 2013, at 11:27 AM, mhj321 wrote:

    Beta Baloney

    'Past investment performance is not an indicator of future investment results' is a required, responsible, and absolutely true investing footnote; an investing fact that anyone who has spent more than a nanosecond in the financial markets would or should know, and an investing law designed to protect the investing naive, innocent, and unsuspecting.

    Then why would one blindly place his/her trust in the present and his/her hope for the future in a mythical investing science - Modern Portfolio Theory and all of its illegitimate relatives such as Monte Carlo Analysis, Efficient Frontier Analysis, Beta, Brinson's Asset Allocation, Pie Charts, and a distant relative, Technical Analysis (worth a glance) - that relies solely on past performance investment data to feed hypothetical and contrived investing algorithms in a misguided effort to predict future investment results?

    All are just other ways to record and to illustrate investment history without valid analytical, interpretive, deductive, predictive, or directional investment value.

    Yet knowing that past performance is not an indicator of future investment results, most investment advisors, money managers, and individual investors build their investment advising and investing performance cases by defiantly applying flawed past performance investing concepts - such as Modern Portfolio Theory, Monte Carlo Analysis, Efficient Frontier Analysis, Alpha, Beta, Standard Deviation, VaR, Sharpe Ratio, and Investing Technical Analysis:

    • Because little or no investing judgment or skill is required; just scan, sort, pick, retrieve, view, print, present, and hope that the investing past will somehow become the investing future.

    • By stubbornly using investing software tools that base all calculations, conclusions, and projections on past investment performance data; performance more by chance than by design.

    If this investing nonsense were valid, there would be no need for investing analytics, forecasting, or guidance of any kind - research, analysis, opinion, advisors - and one would simply select investments based on past performance without regard to suitability, quality, structure, or risk.

    Explained another way, a thermometer measures temperature in degrees as the weather changes.

    A thermometer is a recording device not a forecasting one and, therefore, it cannot be used to predict future temperature levels.

    Standard Deviation, Efficient Frontier, Beta, VaR, and Sharpe Ratio are much like a thermometer; merely means to measure past (contrived) relative investment performances between investment variables and neither the cause of nor the predictor of either.

    Furthermore, if a thermometer also happened to store prior temperature readings on a daily basis, you certainly would not retrieve that information and use it to predict tomorrow's or next week's temperature readings.

    As one would have to analyze the weather-changing causal variables that affect weather, such as humidity and barometric pressure, to predict future temperature levels.

    The same holds true for historical Standard Deviation, Efficient Frontier, Beta, VaR, and Sharpe Ratio readings as a basis for predicting the investing future.

    Future investment values and associated investment/investing risks can only be meaningfully understood and predicted based on one's correct understanding and interpretation of the fundamental performance changing, causal investment performance variables that actually affect an equity's behavior.

    Keep in mind, there is no theory - modern or otherwise - that can be ordained, no computer that can be programmed, no software that can be designed, no investing tool that can be 'imagineered,' no technical analysis voodoo methodology that can be contrived, and no equation that can be divined to quantify, evaluate, and predict the primary forces that drive the sublime chaos of the financial markets and investment prices; human consensus, mood, and behavior; intelligent and not, knowledgeable and not, reasoned and not, rational and not, and logical and not.

  • Report this Comment On March 24, 2013, at 11:49 AM, DadinWestchester wrote:

    I'm glad that the Fool is seeing GE as a potential good investment. In the past I have been at odds with their rally for short bets and dissing this company. I am heavily invested in GE and lost a fortune when they went from $60+ down to $17. I still continued to add to my investment and have used that money to put two kids through college and another one going into med school and paying some bills. Thank G@d for dividends. I have faith.

  • Report this Comment On March 24, 2013, at 12:18 PM, glenns45 wrote:

    Buy MCD, PEP, T, Collect the dividends and hold for the long term and buy ETFS.

  • Report this Comment On March 24, 2013, at 2:36 PM, ethanfrome wrote:

    Dear "glenns45",

    It might be wiser to suggest to everybody that they buy as much of WHX, DCIX, or CFP as they can. These have all been giving more than 15% annual yield for the last few years and each one of them in less than $7 a share.

    MCD is at $99 a share.

    Pep is at $78 a share.

    T is at $36 a share.

    Right now there are lots of "poor" people who could afford to buy 100 shares of CFP for the price of 8 shares of MCD.

    AND they'd actually get more dividends per year by total dollar amount if they did it that way.

  • Report this Comment On March 26, 2013, at 5:11 AM, Mark2013 wrote:

    I'm either an idiot who loves risks or a much wiser investor of 33 years than opinions in this article but since I find long term; CAT, BAC & AA TO NOT be risky, I'll buy, hope for a pullback or crash then load the truck.

    AA has free cash flow of 1.5 billion and is a needed company trading well below book, I'll add share next few trade days and would love to get more BAC under $5 again but am content with all my longs.

    JMO

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