Friday, November 13, 2009

Why investors should ignore the Dow

 

The 30-stock index represents the market to many people. But few of the stocks are worth buying, and a third should be dumped fast. If you don't own them, why follow them?

[Related content: Dow, stocks, investing strategy, stock market, GM]

By James Dlugosch, InvestorPlace

Rightly or wrongly, the 30 stocks in the Dow Jones industrials ($INDU) define the U.S. stock market for millions of people. Lots of funds, 401k's and individual retirement accounts rise and fall based on what the index does.

What numbers tell the most about the economy

So here's a scary thought: Only a handful of the 30 companies in the Dow are worth buying right now, and more than a third should be dumped immediately.

Take Bank of America (BAC, news, msgs). Despite $20 billion in bailout funds and a $118 billion backstop on loan losses, the company still managed to lose $2 billion in the third quarter. The government has guaranteed it won't go broke, but it's hardly an economic leader.

Or consider General Electric (GE, news, msgs). Profit dropped 44% in the third quarter, and the company recently announced plans to lay off an additional 3,000 workers. Yes, it's still one of the world's biggest manufacturers, but its stock price, near $14, is down from $40 two years ago, and the Jack Welch glory days are behind it.

This at a time when the broader economic indicators -- last week's robust gross-domestic-product report, for example -- seem to be pointing up. The market has been rallying since March. Certainly some members of the Dow 30 would be expected to lag, but more than half?

Times like this show the Dow is basically meaningless. Too many of the component companies are former kings of industry that simply have little to say about where the broader market is heading.

In short, the Dow isn't a group of stocks you'd want to own and much less one the whole market should follow.

More from MSN Money and InvestorPlace

Warren Buffett © Matthew Cavanaugh/epa/Corbis

The Dow's identity crisis

If the past 18 months have taught investors anything, it's that change is the only constant on Wall Street. And this makes the Dow all the more frustrating.

The Dow was founded in 1896 in an effort to reflect the stock market and take the pulse of the broader American economy. The 12-company lineup was a pretty good sampling of the era, featuring utilities, sugar growers and railroads. But in the years since, the Dow has morphed into a patchwork index with no real meaning.

Take the most recent changes to the Dow, made last year: Kraft Foods (KFT, news, msgs), Travelers (TRV, news, msgs) and Cisco (CSCO, news, msgs) replaced bailed-out busts American International Group (AIG, news, msgs), General Motors and Citigroup (C, news, msgs).

But why was Citi shooed away while Bank of America, nearly as dependent on Uncle Sam, remained? And why add Cisco, a stock that peaked in 2000, rather than more-influential tech names such as Apple (AAPL, news, msgs) and Google (GOOG, news, msgs)?

More frustrating is the fact that it took the worst market shakeup since the Great Depression to get GM off the list. If GM hadn't gone bankrupt, it would still be in the Dow, though it and the U.S. auto sector had been declining for years.

Video: Does Dow 10,000 even matter?

Those three are gone, but many of the remaining components aren't much better. Fundamental analysis of earnings performance and sales growth for the Dow 30 leads me to believe that more than a third of the stocks are ones I'd advise investors to dump.

These 13 companies have been struggling to turn a profit, have lost market share or have seen their stock prices plummet -- or all three -- over the past couple of years. Do we really want them to represent the U.S. market?

(