The Curse of the Dow

Stocks usually take a hit in the first year after being added to the venerable index.

Watch out, Cisco and Travelers. If you think that by being added to the Dow Jones industrial average, you're joining an esteemed club of established American businesses with heft and staying power, think again. Inclusion in the Dow is a bit of a dubious distinction, akin to appearing on the cover of Time as "Person of the Year," just as one's popularity and public image are peaking. Recall the renown Rudolph Giuliani enjoyed post-9/11, and you get the picture.

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Row 1 - Cell 0 The Dow is an Outdated Index

Over the past ten years, stocks that have been added to the Dow lost an average of 20% in the first year after inclusion. Some have done considerably worse.

Take Microsoft (symbol MSFT), which joined on November 1, 1999, at the height of the dot-com bubble. Microsoft began trading that day at $38.21 and proceeded to fall 25% in the following 12 months. At its June 10 closing price of $22.55, Microsoft shares are 41% lower than they were nearly a decade ago. Fellow tech giant Intel (INTC), which joined the Dow at the same time Microsoft did, actually advanced, by about 18%, in the first year after its addition. But at its current price of $16.46, the stock is 52% below where it was when it joined the Dow club.

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Then there's American Insurance Group (AIG), of "too big to fail" fame. It joined in April 2004, and its share price dropped 32% the first year. The rest, including colossal write-downs and several government bailouts, is history. You don't want to know how much its shares have fallen since joining the Dow (okay, at $1.60, they're down 98%). Dow Jones booted the once-dominant insurer from the average last fall.

Amazingly, the tale of Bank of America (BAC) is even sadder. It joined the average in February 2008, just a month before the collapse of Bear Stearns provided an early look at the chaos into which the entire financial-services sector would plunge later in the year with the demise of Lehman Brothers. BofA didn't help matters by acquiring troubled Countrywide and Merrill Lynch in 2008. More than a year after its inclusion, BofA's stock, now at $11.98, is down 70%.

Elizabeth Harrow, an analyst with Schaeffer's Investment Research who recently wrote a report on the supposed curse, says a lot of optimism surrounds a company when Dow Jones names it to the industrial average. "That, of course, sets the stage for disappointment," she adds.

Is there really something to this curse? "It's a function of how the Dow is constructed," Harrow says. "By the time you gain representation in the Dow, you're no longer in a growth cycle and you're kind of a cyclical stock."

That assessment seems a little unfair, says Charles Carlson, contributing editor of the Dow Theory Forecasts newsletter. To be sure, the Dow is an index of large blue chips that are past their growth spurts. The smallest of the index's components, Alcoa (AA), has a market capitalization of about $11 billion. But taken as a whole, the stodgy index has actually performed a little better in recent years than Standard & Poor's 500-stock index, professionals' go-to benchmark for U.S. stock-market performance. Over the past year through May 31, the Dow lost 30.5%, while the S&P 500 sank 32.6% (the figures include reinvested dividends). Over the past ten years, the Dow was virtually unchanged, while the S&P dropped an annualized 1.7%. "If the Dow is cursed, then whatever the S&P 500 is doing is really cursed," says Carlson.

And not every new Dow stock has been an unmitigated disaster. AT&T (T) and Verizon Communications (VZ) performed reasonably well in the year after their inclusion, 1999 and 2004, respectively.

With the industrial average's addition of Cisco Systems (CSCO), a maker of networking gear, and insurer Travelers Companies (TRV) -- the latter, ironically, once part of the just-dismissed Citigroup -- one can't help but wonder whether the newcomers' fate will follow that of other recent Dow entrants. Both, of course, are great companies; otherwise, they wouldn't have been added to the Dow in the first place. Investors, however, may want to spend their time and energy looking for companies that may be Dow-worthy ten to 20 years from now.