Investing

After Apple Added to DJIA, at Least 3 More Dow Stocks Could Get Booted

Wall Street/NYSEThe team members at the S&P Dow Jones Indices group made a bold decision by removing AT&T Inc. (NYSE: T) from the Dow Jones Industrial Average (DJIA) and replacing it with Apple Inc. (NASDAQ: AAPL). While 24/7 Wall St. has outlined what investors need to know about this key change, there is something else that many investors may be wondering about: which Dow stocks could get booted off of the index next. And which companies might actually replace them if they do?

It turns out that there are three potential changes that could be made in the Dow. Before you go making any big bets here, understand that the Dow team does not like making sweeping and broad changes to the DJIA. It may be an outdated index, but it is perhaps the oldest key stock market barometer, and it is supposed to represent the broad financial markets outside of utilities and transportation.

Of the three changes that could come down the road, these could be in Big Pharma, in financials and banks, and in key industrials.

Many companies have been removed from the DJIA in modern years. Companies like Philip Morris (now Altria), Honeywell, Hewlett-Packard, Kraft Foods, Bank of America, Citigroup, General Motors, AIG, Eastman Kodak, International Paper and others have all been removed from the Dow.

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If you go back to 1999, only 20 of the current DJIA stocks will remain after AT&T is dropped. If you go back to 1987 (before the crash), only 13 of the current 30 Dow members are still in the index, after considering AT&T.

Here are three potential changes that could be seen in the years ahead as the next round of DJIA index changes are made. Again, they could take years, or just never occur.

Health Care and Big Pharma Could Change … to Big Biotech?

Pfizer Inc. (NYSE: PFE) and Merck & Co. (NYSE: MRK) have both been restructuring in a manner that either company could potentially be split up by management. Then there was the planned tax-inversion strategy that was once pursued by Pfizer. DJIA stocks are supposed to industry dominators, and while these both dominate Big Pharma, their growth days are in the past and the ongoing patent expiration cliff has been a continued source of misery. Pfizer is worth $210 billion, versus $163 billion for Merck. If either company splits into two, the company could be jettisoned by S&P Indices off the DJIA (as happened to Kraft).

Who would replace Pfizer or Merck if they were booted?

Would S&P dare to become new age on us? Would it dare to consider adding a biotech giant like Gilead Sciences Inc. (NASDAQ: GILD)? Gilead has a market cap north of $154 billion, it has a low forward price-to-earnings (P/E) ratio of about 10, and it still has revenue and earnings growth projected ahead. Oh, and Gilead even recently announced that it would begin paying a dividend, which now would be about a 1.7% yield. Most investors are still betting big on the future of biotech. The question is whether Gilead’s market cap will keep rising to the point that it passes Merck or Pfizer, as well as whether Merck and Pfizer can get growth back on track and remain single companies.

Is Big Biotech is the new generation of Big Pharma? Please note that if the index team at S&P added a biotech to the Dow, it might be an earth-shattering change, as biotech has never ever been a part of the Dow.

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Financials and Money… One or Two to Boot?

Travelers Companies Inc. (NYSE: TRV) is one of the two financial stocks that 24/7 Wall St. believes could be replaced on the DJIA eventually. In fact, it is a very safe bet that very few investors even really know that Travelers is a DJIA stock. The company is a top provider of property casualty insurance for auto, home and business, and it had roughly 30,000 employees and about $27 billion in revenues in 2014. Travelers was added to the DJIA in 2009, mainly because it was considered a safe financial company at the time.

American Express Co. (NYSE: AXP) has been a DJIA stock since 1982. Warren Buffett is its largest shareholder. Its diversity is just not as much as it used to be. Gone are the days when you could go to an American Express retail branch office and do things like buy travelers checks and conduct business. Now it is mostly a credit card outfit. Visa Inc. (NYSE: V) was even added to the Dow, and Visa is more representative of the broad public than is American Express. The company has an $82 billion market cap and a poor 1.3% yield, while Visa also has a low sub-1% yield, though its market cap is literally double that of American Express. American Express just does not feel like a Dow stock anymore at all.

Now that Bank of America Corp. (NYSE: BAC) and Citigroup, Inc. (NYSE: C) have been booted from the Dow, there was a clear signal that the index team did not want to have any more bank implosions on their hands. After all, all the banks were at risk of failure — or were they? J.P. Morgan Chase & Co. (NYSE: JPM) had the fortress balance sheet, and Jamie Dimon insisted during and after the financial crisis that his bank was safe and would have survived. It stayed in the Dow. Wells Fargo also insisted that it would survive the crisis.

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Now the most obvious financial addition is Wells Fargo & Co. (NYSE: WFC). Wells Fargo does have a solid brokerage and asset management unit, but it has been far less involved in all the derivatives and proprietary trading operations that was effectively a financial market casino financed by the U.S. depositor base. Wells Fargo is now effectively the backstop for the U.S. mortgage market, which is good now but could be bad if housing flops again. Oh, and Buffett’s Berkshire Hathaway is also Wells Fargo’s largest shareholder.

Heavy Industrials … in Favor of Car Makers Again?

Caterpillar Inc. (NYSE: CAT) is one of the most famous American industrial brands. It makes heavy equipment that is bought and used for heavy construction, mining and large infrastructure projects all over the world. The note here is not just that growth has stalled and that it is now heavily dependent on growth markets outside of the United States. Now that shares are down over one-quarter from their all-time highs, Caterpillar has a market cap under $50 billion. Revenue was $55 billion in 2014 and 2013, down from $65 billion in 2012.

Would the indexers dare to go back to the auto sector? Are cars safe? Ford Motor Co. (NYSE: F) and General Motors Co. (NYSE: GM) could both replace Caterpillar if the indexers feel that cars must be bought around the world, with tens of millions of units having to be purchased regardless of the economy. Still, the businesses remain highly cyclical, even if the post-recession auto makers are safer than before.

One potential hurdle exists to adding Ford or GM to the DJIA. GM was a DJIA stock before being ousted in 2009, after having been a member since the 1920s. Also, and more importantly, the old GM did go bankrupt before getting a government bailout and coming back as a public stock after renegotiating its debt with bondholders. GM has a market cap of almost $60 billion and 2014 sales were $156 billion. Ford has a market cap of $63 billion and its 2014 sales were $144 billion. Would the indexers dare go back into cars? That remains to be seen.

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