The Dow's Rising Stars

Although the Baltimore Orioles' Cal Ripken is headed to the Baseball Hall of Fame, his peak performance years were those just after he competed in his first All-Star game. Companies chosen for the Dow 30, the corporate equivalent of the All-Star team, also tend to perform extraordinarily well for the 5 and 10 years after they're chosen for membership in the Dow. A strategy that capitalizes on these observations just might prove very profitable.

By Ethan Haskel (TMF Cormend)
October 4, 2000

Cal Ripken, the Baltimore Orioles' legendary infielder, recently announced he was going to delay retirement and suit up for yet another year. Although Ripken has been worshipped throughout most of his 20-year career in my baseball-crazed town, the local response to his announcement was muted, to say the least.

I hate to say it, but Cal ain't the player he once was. His career stats tell most of the story. Here are some of his batting statistics, comparing his average annual production for the five-year period immediately after he was elected to his first All-Star team in 1983 to that of his last five seasons (1996-2000):

          Home Runs  RBIs    Batting Average
'83-'87      26       95         .286
'96-'00      18       71         .278
One doesn't have to be a rabid baseball fan to see that Cal's production has tapered off significantly since earning that first All-Star berth, despite playing his later years in Camden Yards, a more batter-friendly stadium than Baltimore's old Memorial Stadium. Yet despite his recent modest field performance, Cal's price tag has never been higher. Oriole's owner Peter Angelos paid him more than $6 million last year to play in barely half the team's games.

Today's working hypothesis is that there are similarities between Cal Ripken and the blue-chip Dow companies.

Like our then-rising superstar selected for his first All-Star game 17 years ago, companies newly chosen for the Dow are usually at their peak, or expected to reach their peak, in the next few years. As time passes, conditions and expectations change, both for Cal and our Dow companies. Athletes get injured, or their natural abilities diminish. Similarly, Dow companies mature, economic conditions change, or companies face shifts in their product cycles.

The list of Dow companies experiencing this cycle seems endless. Four recent struggling Dow outcasts -- Goodyear Tire <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GT)") else Response.Write("(NYSE: GT)") end if %>, Sears <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: S)") else Response.Write("(NYSE: S)") end if %>, Union Carbide <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UK)") else Response.Write("(NYSE: UK)") end if %>, and Bethlehem Steel <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BS)") else Response.Write("(NYSE: BS)") end if %> -- are just a few companies that were once viewed as nearly invincible titans of American industry. Alas, like Cal, these companies' glory days are now long past.

Last week we observed that for the last two Dow composition changes (in 1997 and 1999), the stock performance of the Dow newcomers easily beat those of the outcasts. As investors, it makes sense to buy companies as they approach their peak years -- when they are chosen for their first All-Star team. And what better corporate equivalent to the All-Star team is there than the Dow 30? Such "Dow Rising Stars" have bright prospects and lots of positive momentum. They might just turn out to be big winners.

We've seen that the most recent Dow newcomers have easily outperformed the outcasts. Let's now examine a larger sample. Here's the recent history of the other Dow changes, going back to 1976. (Between 1959 and 1976, there were no changes in the Dow.)


Year    Outcast             Newcomer             
1976    Anaconda            Minnesota Mining (3M)
1979    Chrysler            IBM
1979    Esmark              Merck
1982    Manville Corp.      American Express
1985    General Foods*      Philip Morris
1985    American Brands     McDonald's
1987    Owens-Illinois      Coca-Cola
1987    Inco Limited        Boeing
1991    Navistar Intl.      Caterpillar
1991    Primerica           J.P. Morgan
1991    USX Corp.           Walt Disney
*Acquired by Philip Morris
Looking over this list, I don't think we have to run the actual numbers to see that the newcomers are way ahead of the outcasts. All the newcomers have thriving businesses and are household names, while most (though not quite all) of the outcasts have faded to relative oblivion. It would be quite a task just tracking down many of these outcasts, no less tracking their stock performance. We'll chalk up another victory for the newcomers.

Finally, let's check on the performance (total return, including dividends) for our Dow Rising Stars in the years immediately after they were included in the Dow. 



                  5-Year  Return(%) 10-Year Return(%) 
                   Stock    Dow      Stock    Dow     
3M                   9.2    -4.4     179.6    80.8  
IBM                 42.3    31.3      54.2   197.2
Merck               64.5    31.3     741.1   197.2
American Express   279.4   198.5     162.8   269.7
Philip Morris      499.4    77.5    1255.8   246.4
McDonald's          73.2    77.5     464.1   246.4
Coca-Cola          270.5    41.4    1115.9   212.3
Boeing              89.3    41.4     355.9   212.3
Caterpillar        173.5    86.4     232.0*  264.7*
J.P. Morgan         87.2    86.4     338.5*  264.7*
Walt Disney        101.9    86.4     314.7*  264.7*

Average            153.7%   68.5%    474.1%  223.3%
*since 5/06/91
These Rising Stars have done extraordinarily well since being named to the Dow All-Star team. Within five years of being named, only one of the 11 (McDonald's) has underperformed the Dow, and only by a small margin. As a group, they've more than doubled the average return of the Dow, for both the 5- and 10-year periods after being added.

We've seen that it would have been very profitable indeed to invest in these Rising Stars when they were first included in the Dow. Next week, I'll explain a very simple strategy that can take advantage of these observations, complete with 20-year backtested results. 

Beating the S&P  year-to-date returns(as of 10-03-00):
Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %>           +20.7%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %>            +31.7%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>        -9.2%*
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %>    +11.0%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %>         +14.8%
Beating the S&P                +13.8%
Standard & Poor's 500 Index     -2.9%
*Includes Visteon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VC)") else Response.Write("(NYSE: VC)") end if %> spin-off


Compound Annual Growth Rate from 1-2-87:
Beating the S&P               +23.9%
S&P 500                       +16.6%


$10,000 invested on 1-2-87 now equals:
Beating the S&P             $191,000
S&P 500                      $83,000