There is arguably no stock market index that is followed more intensely than the Dow Jones Industrial Average (DJINDICES:^DJI).
Comprised of just 30 megacap stocks, the Dow Jones is designed to represent a variable mix of the industries that are most important to the U.S. economy. Over its more than 100-year history, dozens of names have shuffled in and out of the Dow as the dynamics of the business world changed and certain sectors faded or grew in importance.
The Dow is also a mainstay investment for smart money. Smart money loves the Dow Jones Industrial Average because these stocks typically come with three key features. First, they tend to sport lower volatility than the average of what you might get across all 500 stocks of the S&P 500. Volatility is great for options traders, but most investors prefer steadier moves as opposed to herky-jerky up and down days. Second, Dow components are cash cows. Most are multinationals and generate significant positive free cash flow, and all of them are profitable year after year. Finally, all 30 Dow components pay a dividend. The easiest way to attract smart money is to reward shareholders with a regular payout.
Why smart money loves this Dow stock
However, investors should also keep in mind that the Dow's 30 components aren't all created equally. Smart money particularly loves one Dow stock.
That company is most definitely not IBM (NYSE:IBM) or McDonald's (NYSE:MCD). Although these companies offer investors a strong history of dividends, IBM is in the middle of restructuring its business to focus on cloud computing rather than static software, while McDonald's menu has grown so large and complicated that it is hurting sales and forcing the company to try new marketing tactics. This isn't to say IBM can't turn its business around at some point, or that McDonald's new CEO, Steve Easterbrook, won't be successful in making the Golden Arches shine once again, but neither company offers particularly attractive growth prospects over the intermediate term. It also goes to show that smart money typically likes to see substantial long-term growth prospects.
A bad news event can also ensure smart money investors keep their distance. For example, American Express (NYSE:AXP) has had a rough 2015 so far following the announcement that its alliance with Costco Wholesale would expire in 2016. Costco represents about a tenth of all AmEx cards in circulation, and it accounted for 8% of AmEx's total billed dollar volume last year. In other words, while AmEx still has loyal, affluent customers to keep its cogs well-oiled, it could struggle to grow in coming few years as it adjusts to life without Costco.
Ultimately, the Dow stock smart money loves most of all is the index's newest addition: Apple (NASDAQ:AAPL).
Why smart money loves Apple
The way I view it, smart money flocks to Apple for four reasons.
To start, consumers absolutely love the brand, as shown by the long lines in front of its stores when a new product is released. Apple is known for its almost cult-like following, which tends to lead to strong sales results. High consumer loyalty also means consumers are willing to pay a premium for Apple products relative to other brands. There are certainly cheaper smartphones and laptops to choose from, but people buy Apple because it's a brand they can trust.
Second, Apple has a mountain of cash and incredible annual cash flow potential that protect the company from any major downside or volatility. Including cash held abroad, Apple ended its latest quarter with $178 billion in cash. This provides plenty of motive to continue repurchasing shares or raising its dividend.
Third, and adding to the last point, Apple has been a strong advocate for shareholder returns over the past couple years. When Steve Jobs ran the company there was no emphasis on share buybacks or a dividend. However, in the Tim Cook era Apple has boosted its share buyback offering from $45 billion in 2012 to $130 billion in 2014. Meanwhile, its dividend has spiked by 24% since 2012. It's widely believed that Apple will again raise the payout when it next reports quarterly results.
Last, but most important, Apple is an innovator. It is now both a product developer and a platforms company that is capable of driving growth for years to come. Apple's mobile pay platform could revolutionize the way we pay for items by making it faster and more secure than ever. Furthermore, its smartwatch could be just the tip of the iceberg when it comes to personalizing wearable technology. And the 74.5 million iPhones Apple sold in the company's first quarter? Yeah, that wasn't too shabby, either! If you thought Apple's days as an innovator were long behind it, then you thought wrong.
Despite its share price rising more than 50% over the trailing 12-month period, smart money continues to see ample upside to this stock. With expectations of $50 billion-plus in free cash flow, a forward P/E of just 13, a yield of 1.5%, and a modest PEG ratio of 1.1, I'd have to agree that there is much to like with Apple.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool owns shares of, and recommends Apple and Costco Wholesale. It also owns shares of International Business Machines, and recommends American Express and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.