Bigger Is Better
by MF MerlinI've read and re-read Michael O'Higgins' "Beating The Dow" (BTD) and observed that he repeatedly emphasizes the importance of restricting stock purchases to large capitalization stocks. His rationale is that the vast resources of such companies make them virtually immune to destruction and enable them to recover from almost any adversity. In his book, he specifies that stocks be chosen from the 30 stocks making up the Dow Jones Industrial Average. Some past postings on the BTD message board have suggested that the stock selection universe be expanded to include the stocks in some more-comprehensive market index like the S&P 100 or the S&P 500. It was further suggested that this larger universe be scrubbed down to come up with a new, diversified set of 30 big-cap, dividend-paying, industrial stocks.
I don't believe that it's necessary to restrict the stock selection universe to any pre-established index; nor do I think it's necessary to boil the selection universe down to some specific number of stocks. But I do agree with O'Higgins' that the stocks selected should be BIG. In my view, if big is good then bigger is better, and biggest is best of all. In other words one should select one's investments from the stocks of the very largest companies.
How does one determine which of the thousands of companies are the largest? It's easy. Business Week magazine publishes a list once a year. This year's list came out in the March 27 issue, and includes a table entitled "The Business Week 1000." This lists the 1000 largest U.S. companies in descending order according to their market value. The table also contains other valuable data about each company including information about sales, profits, assets, stock valuation, dividends, institutional holdings, and actual and estimated earnings per share. You can download a copy from the Business Week Online forum in the Newsstand Department of AOL. A list of the top 100 stocks can be found in the Hoover's Business Resources forum. (Keyword: Hoover)
How do the DJIA stocks stack up against the BW list? Here' s what I found. Nine of the top 10 market value stocks are DJIA stocks, but only 12 of the top 30 are DJIA stocks. Of the top 50 stocks only 18 belong to the DJIA. Of the top 100 only 23 are DJIA stocks. The remaining 7 DJIA stocks rank 109, 133, 173, 174, 229, 466, and 526. Number 526 was 1994's penultimate disappointing performer---Woolworth.
Summing up: 1) Some of the DJIA stocks were indeed among the largest capitalization stocks, 2) Some of the DJIA stocks, relatively speaking, were not all that largely capitalized, 3) There are many companies that are larger than many of the companies making up the DJIA.
If you want a stock-selection universe of 30 stocks then you could choose the first 30 companies listed in the Business Week list, 18 of which are not DJIA stocks. Included in this non-Dow group are such familiar names as Wal-Mart (rank 5), Microsoft (rank 11), Johnson and Johnson (rank 12), GTE (rank 17), Pepsico (rank 21) and 13 other giant corporations---all with market values of more than $25 billion. If you want to consider all stocks with market value of $20 billion or greater, you would choose the top 37 stocks on the Business Week list. Similarly, 53 stocks on the list have market values greater than $15 billion, and 84 greater than $10 billion.
Whatever universe you select from, you should also screen your candidate stocks for relative price appreciation potential. O'Higgins does this with the Dow 30 stocks by selecting those with the highest dividend yields. That method has worked well for the Dow stocks, and should work equally well for the "Bigger is Better" stocks. I must admit, though, that the "Bigger is Better" approach hasn't been back-tested as has the BTD. Still, I think that the approach is totally consistent with the stock selection philosophy expressed by O'Higgins in "Beating The Dow."
The Business Week 1000 is updated every year, so by choosing from this list year after year you would always be selecting from the currently largest companies. It's a little more work than picking strictly from the Dow 30. But, when it comes to investing, sometimes a little more research can make the difference between a profit and a loss. In my opinion, if you could avoid another Woolworth, it would be worth the trouble.