Thursday, May 28, 2009

Google in Dow: are you kidding me? A look at possible replacements.

It’s almost a foregone conclusion that General Motors (GM) is going to be replaced from the Dow. People have started speculating on possible replacements:

From Yahoo Finance:

In a research note last month, Nicholas Colas, chief market strategist for BNY ConvergEx Group, laid out seven possible replacements for GM: bankers Goldman Sachs Group Inc.(GS) and Wells Fargo & Co.(WFC); high-tech firms Cisco Systems Inc.(CSCO), Apple Inc.(AAPL), Google Inc.(GOOG) and Oracle Corp.(ORCL); and agricultural products maker Monsanto Co.(MON).

Based on the market moving impact of high price stocks on the Dow index, I would safely rule out Google, and even Goldman Sachs and Apple would be pushing the envelope. Why? If Google were to be added at the current price, it would comprise 28% of the Dow index! Thus Google CANNOT possibly be a serious candidate for the price weighted Dow. With close to 10%, the biggest weight in the Dow currently is IBM. Even Apple or Goldman Sachs would contribute close to 11% and 12% respectively to the index, which is why I think their addition to the index is unlikely.

If that’s not reason enough, here’s another fact: What's the number of current Dow components not paying a dividend? Answer: ZERO. If this were to hold true going forward, that would rule out Google, Apple and even Cisco from the list of contenders. (Now, I know Cisco CEO John Chambers has promised a dividend before he quits, but that’s not happened yet.)

So assuming the analyst got the initial list of candidates right, there are only three possibilities in my opinion: Oracle, Monsanto and Wells Fargo.

I did some further reading and pulled together a list of additional replacement candidates from various commentators:

  • WSJ’s Marketbeat suggests Deere (DE), Toyota Motor(TM), and British Petroleum (BP).
  • Felix Salmon adds Amgen(AMGN) and Nike (NKE) to the list.
  • CNN Money suggests Pepsi(PEP), Conoco Philips(COP) and Schlumberger(SLB) as additional names.

  • Fox Business quoting Wall Street analyst Matthew Hougan adds Philip Morris (PM).
  • This Reuters article further suggests Aetna(AET), FORD (F), Nucor(NUE) and Travelers(TRV).
  • This CNBC article suggests, in addition to the names listed above, Amazon (AMZN) and Abbott Labs(ABT)

After the removal of Honeywell(HON) and Altria(MO) from the Dow, here’s what the committee had said:

On CVX addition: "As usual when we make any change we review all the stocks. In doing so, we saw that the financials industry was under-represented -- notwithstanding the current turbulence -- and that the oil and gas industry's growing importance to the world economy called for another representative to join ExxonMobil Corp.

On Honeywell removal: “Honeywell is being removed because it's the smallest of the industrials in terms of revenue and earnings. Additionally, the role of industrial companies relative to the overall stock market has been shrinking in recent years.”

At that time, Honeywell had net income of approx. $2.5 Billion, and revenues of ~ $35 Billion.

With Oil down to less than half from the peak, it seems unlikely that the committee would add another oil major, which makes me want to rule out COP, SLB and BP. Further, because of their emphasis on revenues and earnings, I would rule out Amgen, Abbott Labs, Nike, Nucor, Amazon and Aetna.

After adding AIG and BAC in the last 10 years and watching them lose most of their stock value, I’m not too sure how enthusiastic the board will be about adding another financial to the list, except perhaps to replace an outgoing financial.

This would leave: Oracle, Pepsi, Deere, Monsanto, Wells Fargo and Philip Morris as the serious candidates. PM and PEP sound like safe bets in this uncertain environment. Monsanto would be an interesting name given that agriculture could be a big growth industry going forward. One interesting pair which hasn’t been discussed are the drugstore chains, CVS and Walgreens. The Dow is underweight financials and health care compared to the S&P 500, so we could always see a name from those sectors.

If I were to make a guess, CVS/Walgreens, Oracle, Pepsi, Monsanto, Wells Fargo and Philip Morris would be my replacement picks. While I might be wrong on some of my conjectures, what seems certain is that the new Dow entrant is definitely not going to be Google.

Time will tell. Stay tuned!

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