The name of the Dow Jones Industrial Average (DJINDICES:^DJI) clearly indicates its roots in representing the industrial sector. Yet over the years, the Dow has evolved to include stocks from just about every sector of the economy, ranging from health-care and energy stocks to financials and consumer-oriented stocks. That breadth is what makes the Dow relevant for stock market investors of all sorts.
Yet even with its diversification, the Dow still gets more than 20% of its value from industrial stocks, making the sector the most heavily weighted one in the Dow. Is that industrial focus damaging to the Dow's returns? Let's take a closer look.
The industrials of the Dow Industrials
Many of the key stocks in the Dow are squarely focused on the industrial business. Consider the following stocks:
- Boeing (NYSE:BA) has risen to prominence as one of the two premier aerospace manufacturers in the world, catering both to military and commercial needs. The company has identified an opportunity to bring in trillions of dollars in revenue over the next 20 years in order to meet rising demand for more fuel-efficient aircraft, as airlines have improved their profitability and are finally in a position to make more capital expenditures.
- United Technologies (NYSE:UTX) assists Boeing and others by supplying key parts and components for aerospace manufacturing. It also has other industrial businesses, including its Otis elevator segment and various control systems that have a wide range of industrial applications.
- Caterpillar (NYSE:CAT) is a leader in supplying heavy equipment for construction, infrastructure development, and mining.
In addition to these stocks, several conglomerates also fall into the industrial realm at least in part. 3M (NYSE:MMM) is best-known for its consumer-facing office-products lines, but it also has a variety of different businesses that include medical equipment as well as security and protection services for commercial and home safety. And although General Electric's weighting in the Dow is relatively insignificant, the conglomerate still plays a vital role in the U.S. economy and has served as a good barometer of domestic economic activity.
Too much of a good thing?
Put all these stocks together, and more than $1 of every $5 invested in the Dow goes to these industrial giants. That hasn't been a bad thing in 2013, as year-to-date returns among these stocks have generally outpaced the rest of the average, with the exception of Caterpillar. Boeing has managed to bounce back from its Dreamliner disaster as its long-term prospects look incredibly promising. The Goodrich acquisition has helped bolster United Tech's growth and could continue to produce big gains well into the future. And even though Caterpillar faces some challenges, the inevitable turning of the commodity cycle should leave the company better able to compete. Still, with industrial stocks making up less than 9% of the S&P 500, the Dow can experience discrepancies in performance when industrials are outlying returns in either direction.
There's nothing inherently wrong with the Dow's having a greater than 20% concentration to industrial stocks. But investors need to be aware of that concentration if they want to plan accordingly for the risks the concentration creates. Otherwise, Dow investors could get a nasty surprise if the bottom falls out of the industrial manufacturing sector in the future.