Is Dow Addition a Kiss of Death for These 3 Stocks?

The Dow Jones Industrials Average (DJINDICES: ^DJI  ) is cleaning house. After today, Goldman Sachs (NYSE: GS  ) , Visa (NYSE: V  ) , and Nike (NYSE: NKE  ) will replace Alcoa, Bank of America, and Hewlett-Packard.

This raises some interesting questions -- is the Dow's blessing really a good sign for investors? Or is it a kiss of death for outperformance? What's the track record of the new Dow members, anyway?

For all the hype and adulation that goes along with Dow membership, history suggests that the folks picking new members are much better at identifying stocks that have performed well in the past than stocks than those that are poised to perform well in the future:

Performance declined an incredible 86% of the time a stock was added to the Dow.

Now, to be fair, Dow Jones isn't exactly aiming to identify outperformers when it selects new members. As they explain: "A stock typically is added to The Dow only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors. Maintaining adequate sector representation within the indices is also a consideration in the selection process."

And maintaining sector representation in the most prominent industry names during a period of two major bubbles is the big culprit here. Much of the decline in performance comes from giants that were added at the peak of sector bubbles. Intel (1999), Microsoft (1999), AIG (2008), and Bank of America (2008) are prime examples.

Still, when you compare new Dow members to the broader market, they actually do pretty well on average. New members beat the broader market by 32 percentage points over the five years after they're added.

However, keep in mind that this outperformance was largely due to a small group of major outperformers. (Owing the bulk of your performance to a relatively small group of companies is a feature of the broader stock market too.) New Dow stocks usually go on to underperform the market.

So, what are the historical lessons here for investors, particularly those interested in new Dow members like Goldman, Visa, and Nike?

  • Sadly, the pomp that goes along with getting added to the Dow is also a sign that a stock's best days of performance are behind it. This makes sense, because companies grow into their blue chip status, but the law of large numbers, and the extra attention from big investors makes outperformance difficult to continue.
  • Most new Dow members have gone on to underperform the S&P 500, though performance as a group was better than the market as a whole because of a select group of Dow all-stars.
  • It's apparently much harder to separate true "blue chip" companies from momentum stocks nearing the peak of a bubble. Even some genuine blue chip companies can be overvalued momentum stocks.
  • Simply buying a few of the most prominent names with "interest to a large number of investors" isn't as safe a stock-picking strategy as you might think. Even investors interested in prominent stocks still need diversification to make it work.

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  • Report this Comment On September 20, 2013, at 8:15 PM, Babcockk1 wrote:

    I know it's hard sometimes to trust the experts, but sometimes they hit the nail on the head. The hard truth there are unscrupulous individuals that try to steal from the rest of us. I wish the little investor like myself had protection. I gave 210k to Fid___ty and they screwed the pooch for me. Ended up with 148k, 6 months later. I took my money, put it back in my control, 6months later I'm at 250k. That was a wake up call to trust in watching and reading what I believe is truthful. Thank you Motley Fool.

  • Report this Comment On September 20, 2013, at 11:17 PM, spcd7 wrote:

    just one of the pitfalls when greed is in play,keep faith that karma is in play also.

  • Report this Comment On September 21, 2013, at 12:13 AM, wrenchbender57 wrote:

    Same thing happened to me. But it was in my TD Ameritrade account. About 2007 or so it dropped to much less than it had been before that. I left it there and added some to it. A few years later it as all back. So, Babcock, depending on your time frame and happened, exactly, it could be coincidence, a market drop or anything. Not sure your story has anything to do with Fidelity managing your money. You known far more than we do about your situation. Just saying, that your story sounds similar to many others about the time the market had the last big drop and the eventually recovered.

  • Report this Comment On September 21, 2013, at 5:41 PM, mikecart1 wrote:

    Babcockk1,

    Your story isn't unique but you should be proud to have pulled yourself from the Matrix. You were stuck in the machine and you didn't even know it. Your hard-earned work and time and money went to Mr. F in the way of poor mutual fund buys, bad investment advice, and commissions. Now that you are free from the Matrix, you have realized what many others will never do in their lifetime - they, YOU, us, are actually smarter with our money than someone else is with our money.

    Basically, no one will care about your money as much as you do. And that is the only truth in life! :)

  • Report this Comment On September 22, 2013, at 4:07 PM, BMFPitt wrote:

    I hope V has a few lean years so it can get back into a range where I'm comfortable buying it again.

    Been kicking myself ever since I got out at 90 for house money.

  • Report this Comment On September 23, 2013, at 11:16 AM, Mathman6577 wrote:

    Chevron was kicked out of the Dow and did well. They had to be added back in in.

  • Report this Comment On September 24, 2013, at 12:28 PM, EdGrey wrote:

    Goldman Sachs? That must be a stand-in for the whole predatory bankster sector.

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