Dow and Out? Cisco and Travelers Stocks May Languish in Famed Index
The inclusion of Cisco Systems and Travelers in the Dow Jones industrial average signifies their membership in one of the more exclusive and prestigious clubs in the world of investing. But if you're a shareholder in either stock, you may find the dues high and the rewards less than you hoped.
The announcement on June 1 that the companies were replacing Citigroup and General Motors sent the new members' stocks soaring. Cisco, the largest provider of infrastructure for the Internet, rose 5.4 percent and Travelers, the insurance company spun off from Citigroup seven years ago, rose 3.4 percent. The Dow was up 2.6 percent during the session.
The buyers that day did not pick up sure things. Recent history has shown that when a stock enters the most famous stock index in the world, it can be a sign that its best days are behind it.
Look at the crop of Nov. 1, 1999. Two pillars of information technology, Microsoft and Intel, became the first Nasdaq stocks to make it into the Dow.
It was hardly the auspicious occasion that shareholders must have hoped for. In the preceding five years, Microsoft and Intel each rose more than tenfold, easily outpacing the otherwise stellar 175 percent increase in the 30-stock index.
The next five years produced drastically different results. The Dow eased 6.5 percent but left the tech bellwethers far behind. Microsoft was down 38.8 percent, and Intel fared even worse, losing 41.6 percent.
Bad timing? No kidding. Bad luck? Probably not.
The guardians of the benchmark index are not known for being on the cutting edge of commercial developments. Their job is to craft an index that reflects corporate America, not divine the next big thing. By the time they acknowledged that information technology was part of the industrial mainstream more than the heavy manufacturers that dominated the Dow for a century, so had just about anyone else with money to invest.
Another characteristic of Dow constituents that accounts for their weakness after inclusion is that they are recognized leaders in their field. In the cases of Microsoft and Intel, the fields are personal computer operating software and semiconductor chips.
Dow components are invariably known quantities on Wall Street and Main Street, so their many admirable qualities tend to be factored into their share prices already. Yet their preeminence also leaves them vulnerable to new, innovative rivals and other adverse changes in the business backdrop.
That helps explain the performance of Home Depot, a decidedly low-tech company added to the Dow at the same time as Microsoft and Intel. The stock of the big-box home-improvement juggernaut rose more than 400 percent in the preceding five years and then underperformed for the next five, losing 16.2 percent.
So does this mean that Cisco and Travelers are goners whose stocks are destined to leech value from shareholders' portfolios? There is no guarantee that the historical pattern will hold, of course, but it suggests that prospective buyers, especially of Travelers, should be circumspect before taking the plunge.
The insurer shows a 15.5 percent increase in the last five years, compared to a 16.6 percent loss for the Dow. The stock has done extremely well relative to rivals like Chubb and ACE, too.
Cisco has done slightly worse than the Dow, declining 17.3 percent over five years. It has underperformed the Nasdaq by slightly more. It also trades at a much lower valuation than competitors like Alcatel-Lucent and Juniper Networks.
Of the two fledgling Dow members, Cisco seems to have more headroom. They are in very different industries, so comparisons are risky. Still, Cisco is the cheaper of the two and its margins and return on equity are much higher.
But whatever reasons investors may have for adding either stock to their portfolios, inclusion in the Dow shouldn't be one of them.
