How long will the Dow keep its weakest stocks?

By Madlen Read
AP Business Writer / February 19, 2009
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NEW YORK—Some dogs of the Dow have lost their bite.

If prices for the three cheapest stocks in the Dow Jones industrial average -- General Motors Corp., Citigroup Inc. and Bank of America Corp. -- fell to zero, the index would shed fewer than 70 points. That's only about 0.9 percent.

With these three companies worth less than $5 a share apiece, some investors are thinking the Dow should replace them. A $1 move in a Dow stock corresponds to about an 8-point move in the index, according to Dow Jones Indexes.

"I'm certainly surprised they haven't done it," said Jack Ablin, chief investment officer at Harris Private Bank. Ablin said he already considers stocks like GM and Citigroup "ex-officio" members of the Dow.

Dow Jones said it has no plans to shuffle out any components, and does not have any official threshold to determine whether a company should be included or excluded. But it has a history of replacing weak companies with stronger ones, and isn't ruling out any future changes.

"We're watching the situation very closely, and we are not saying that we are standing by these stocks come hell or high water," said Dow Jones Indexes Editor and Executive Director John Prestbo, who helps The Wall Street Journal's managing editor decide which companies go into the Dow. "We're saying that for now, it's our judgment that they continue to be representative of the industries that they're in. When that changes, we'll replace them."

Some Dow stocks are indeed very cheap right now, Prestbo acknowledged, but their tumbles are "the story of the stock market. And that's the purpose of the Dow: To tell the story of the stock market."

The Dow Jones industrial average is far from the be-all-end-all measure of the U.S. stock market. Market participants tend to use broader indexes like the Standard & Poor's 500 index for statistical analysis. Even Prestbo said the Dow is "very subjectively run."

But the Dow is the most-watched stock index in the world, and historically useful because it is so old -- created in 1896 by Wall Street Journal editor and Dow Jones & Co. co-founder Charles Dow. General Electric Co., which sank Thursday to a 13-year low of $9.95, is the only remaining original component.

General Motors is among the oldest Dow components, too, having joined the index in 1925. It's now the smallest company in the Dow by both stock price and market capitalization -- GM's shares have fallen to $2, and its market cap has dropped to $1.26 billion. At their peak in 2000, GM shares traded above $94 -- which is more than the current price of any Dow stock.

GM is one of four stocks trading below $10 a share now, along with Citigroup, Bank of America and Alcoa Inc. It's not a rule of the Dow, Prestbo said, but some investors believe stocks under $10 have no place in the index.

Such a rule "makes sense, in normal times," Prestbo said, but "this is anything but normal. That's why that principle, that guideline, is kind of not applicable."

He added that "we have a history of measuring GM for the auto industry. For the moment, we'll stick with that."

Jeff Hirsch, editor of the Stock Traders Almanac, said it wouldn't make sense to shuffle out the Dow's cheaper companies considering how weak the rest of corporate America is.

"Show me a company that's worthy of replacing one of the 30, and I would consider it," Hirsch said. "I don't see it myself."

When the Dow replaces a component, it often does so with another stronger company in the same industry. In the late 1990s, Home Depot Inc. took the place of Sears Roebuck & Co., while Wal-Mart Stores Inc. succeeded Woolworth Co.

Jefferies & Co. chief market analyst Arthur Hogan said that another bank like Wells Fargo & Co. could replace Citigroup or Bank of America, while a transportation company like UPS or FedEx Corp. could succeed GM.

Hogan argued also that the Dow's job is to not only to reflect what is going on in certain industries, but also represent the most influential industries in the U.S. economy. Once dominated by railroad companies and industrials (hence its name), the Dow Jones industrial average now includes many technology and pharmaceutical giants.

And last fall, after American International Group Inc. was taken over by the government, Dow replaced the insurer with a consumer staple brand: Kraft Foods Inc.

The Dow kicked out Honeywell Inc. last year, too, in favor of Bank of America -- not because Honeywell was weak (Honeywell's stock has been doing much better than BofA's) but because industrials have become a smaller part of the economy, Prestbo said.

The quandary now is whether the economic roles of automakers and banks are shrinking, too -- and whether that should that be reflected in the Dow.

"It begs the question," Hogan said, "is it representative of industries that are important in a current analysis of the U.S. economy?"

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