<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (April 6, 1998) -- Two news stories dominate the Dow arena today -- one minor but positive, the other colossal.

First the appetizer. Alcoa <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AA)") else Response.Write("(NYSE: AA)") end if %> launched the first-quarter earnings season today by posting a 32 percent increase in profits over last year. First Call's consensus estimate for the quarter was $1.06 per share. Alcoa posted $1.24, compared to last year's 91 cents. The stock jumped almost 1% on the news. A good start to the first quarter earnings season.

Now for the $70-billion-course menu. In a blockbuster announcement that took Wall Street very much by surprise, banking behemoth Citicorp <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCI)") else Response.Write("(NYSE: CCI)") end if %> and financial services titan Travelers Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRV)") else Response.Write("(NYSE: TRV)") end if %>, a recently added component of the Dow Jones Industrial Average, this morning announced their intention to merge. By nearly a factor of two, this would be the nation's largest merger in history. The largest to date was the $37 billion deal between MCI Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %> and WorldCom <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCOM)") else Response.Write("(Nasdaq: WCOM)") end if %>.

I won't rehash the banking and industry implications here as there's a very good article already posted in today's Lunchtime News on the merger, but I'd like to focus instead on possible implications for the Dow itself.

As you may know, the components of the DJIA are determined solely by the editors of Dow Jones & Co., publishers of The Wall Street Journal, Barron's, and partners with CNBC. The question is open as to whether the editors will leave the new company, to be called Citigroup, Inc., in the index.

Whether they do or not, what immediate impact on the index can we expect to feel? None other than Travelers Group's big jump in price today.

The index is calculated by adding the stock prices of the 30 components together and then applying the floating divisor Dow Jones uses to account for stock splits, spin-offs, mergers, and any special event that would significantly affect the level of the index. In other words, when a Dow component splits 2-for-1, the index doesn't take a big hit because a component's price drops from $100 to $50. The divisor is adjusted so that the Dow is identical pre-split and post-split.

The divisor is similarly adjusted when stocks are replaced in the index so that the index remains unchanged by the stock rotation. Let's say Travelers Group is trading at $80 and gets pulled from the Dow as a result of this merger (I'm not suggesting in the least that this is the likely scenario), and is replaced by another stock trading at $30 a share. Obviously it makes no sense that the index should suffer a huge drop in value because of an arbitrary difference in the two stocks' prices, so the editors adjust the divisor to keep the index unchanged by the revision in components.

It's anybody's guess what the proposed merger will do for the composition of the Dow. Will Citigroup stay in the index and replace Travelers, or will the editors pull the new company in favor of something else? Here's your chance to be gooroo for a day. Make your predictions now. But realize that no matter what the result, the index itself won't be affected numerically because of the revision to the floating divisor. Fool on!

Current Dow Order | 1998 Dow Returns

[Robert Sheard is the author of the forthcoming book, The Unemotional Investor, due out from Simon & Schuster on May 12. To pre-order your copy, please visit Amazon.com, where it's available at a discounted price.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   -  15/16  49.13 
 IP   -   5/16  49.00 
 MO   -   3/4   39.25 
 EK   -   7/16  64.13 
 
 
                    Day   Month    Year 
         FOOL-4   -1.23%  -0.91%   5.83% 
         DJIA     +0.55%   2.65%  14.23% 
         S&P 500  -0.12%   1.78%  15.56% 
         NASDAQ   -1.42%  -0.36%  16.48% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  291 Union Carb    42.94     49.13    14.41% 
  12/31/97  289 Int'l Pape    43.13     49.00    13.62% 
  12/31/97  206 Eastman Ko    60.56     64.13     5.88% 
  12/31/97  276 Philip Mor    45.25     39.25   -13.26% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  291 Union Carb 12494.81  14295.38  $1800.56 
  12/31/97  289 Int'l Pape 12463.13  14161.00  $1697.88 
  12/31/97  206 Eastman Ko 12475.88  13209.75   $733.88 
  12/31/97  276 Philip Mor 12489.00  10833.00 -$1656.00 
  
  
                              CASH    $415.96 
                             TOTAL  $52915.09