The Dow Approach
The Dow Approach
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FOOL GLOBAL WIRE LEXINGTON, KY. (Feb. 27, 1997) -- When a Dow stock splits in the forest and no one's there to hear it, does it make a noise? While the resident philosophers tackle all the possible signifiers and interpretations for that one, let's look at a more practical concern regarding stock splits within the Dow approach. In a typical stock split, the dividend pay-out is adjusted by the same ratio as the stock price, so the actual dividend yield (the annual dividend divided by the current price) remains at the same level. The first screen used by the Dow Approach, then, is unaffected. If a stock isn't already among the top ten yielders, a stock split won't magically put it there. A stock already among the high yielders, though, is indeed affected by a stock split. Such will be the case for two Dow stocks in the near future. EXXON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: XON)") else Response.Write("(NYSE: XON)") end if %> announced yesterday that it will split two-for-one and PHILIP MORRIS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MO)") else Response.Write("(NYSE: MO)") end if %> announced that it will split three-for-one. Calculating from today's price levels, though, the splits would launch both stocks into the elite five Beating the Dow spots. Is this a flaw in the system? Not at all. Keep in mind that the essential screen is the high yield. That's not affected at all by stock splits. But once we have the ten highest yielders, we focus on the lowest priced ones, and it's not crucial whether the price is low because of a split or other factors. Theoretically, any one of the ten high yielders is a good stock to hold. But choosing the ones with the lowest prices gives us the advantage of volatility, since our assumption is that the volatility will be to the upside. Think of the market as a large and powerful waterway. When it's racing forward, the stocks with the lowest prices often get swept along more quickly. It's just like putting a cork in white water. If you drop one in a torrent, it gets swept along the surface at enormous speed. Put a big log in the torrent and it'll move quickly, but that cork will zoom past it. Going back to stocks, compare a $20 stock to a $100 stock. They both get caught up in upwards momentum, but a similar dollar movement will affect the cheaper stock much more dramatically. A $2 move in the cheap stock is a 10% gain. The same $2 in the behemoth is only a 2% profit. It doesn't work perfectly every time, of course, but on average those lower-priced stocks will out-perform the higher-priced issues in the high yield group, enough so over the decades that it makes the approach consistently out-perform a straight high-yield model. So it doesn't matter if Exxon and Philip Morris get bumped into the top group by virtue of a split or not. The only real question is for investors who are going to be updating or starting between now and the time the splits take effect. You have the option of using the "official" rankings, or accounting for these two stocks based on their post-split prices. There is no right or wrong answer, since, as I mentioned, all ten high yielders are attractive in this model, but it is an option to consider. For our rankings I will go by the book, ranking them strictly by their actual prices until the splits occur. You're free, of course, to anticipate the new rankings in your decisions, however.
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. |
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