As Nasdaq Challenges the Dow, It’s Time for an Index Make-Over

Dateline: New York, July 8, 2001--The Nasdaq composite stock index crossed the 10,000 mark today for the first time, extending the phenomenal technology rally that began in late 1999.

Meanwhile, the beleaguered Dow Jones industrial average slipped 45.61 points to end at 9,905.66. . . .

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The Nasdaq index over 10,000, and the Dow under 10,000? Dow Jones & Co., the guardian of the world’s best-known stock index, would probably like us all to believe that it wouldn’t be a big deal if it happens.

Right. And Coca-Cola wouldn’t care if Pepsi overtook it as the world’s best-known soft drink.

Take a tip, Dow Jones: It’s time for a radical Dow make-over.

In the 100-year history of the Dow index, Wall Street has periodically argued over its relevance. But perhaps never before has the Dow been so at risk of appearing obsolete. On any given day this year, the question many investors have asked is not “What’s the Dow doing?” but “What’s the Nasdaq doing?”

Powered by the technology, telecom and biotech shares that dominate it, the 4,700-stock Nasdaq composite index roared up 86% last year and is up almost 21% this year, to a record 4,914.79 as of Friday.

The Dow, saddled with too many names that investors rightly or wrongly now view as “old economy,” is down nearly 10% so far this year, even after Friday’s 202.28-point rebound to 10,367.20.

If Nasdaq passes 5,000 this week, as appears quite likely, the what’s-wrong-with-the-Dow? stories will be everywhere.

Is there really something wrong with the index? Dow Jones insists it has always strived to keep the Dow representative of a cross-section of major American industries. The member stocks have changed as the economy has changed.

To its credit, Dow Jones made a major substitution last November, adding Intel, Microsoft, SBC Communications and Home Depot, while booting Chevron, Goodyear, Sears and Union Carbide.

So now the 30-stock Dow includes four major technology stocks (Intel, Microsoft, Hewlett-Packard and IBM).

You can almost hear the laughter over at Nasdaq. Technology is just 13% of the Dow? Even on a share-price-weighted basis (that’s how the Dow is calculated--its highest-priced stocks matter most in determining its moves) those four pure tech stocks account for just 22% of the index.

By contrast, tech stocks in the Standard & Poor’s 500, the broader blue-chip stock gauge, now account for 34% of the index’s value.

Of course, some people say the tech-stock sector is a massive bubble bound to burst. Adding more tech to the Dow now would make it more vulnerable to a sharp decline, they say.

Fine--then the index would at least be a truer reflection of what’s happening in what is arguably the most important part of the market, and economy, today.

Whatever happens next with tech stocks, does anyone really believe that technology as an industry is going to be less significant to America’s economic advancement in three, five or 10 years?

Despite Dow Jones’ changes to the Dow index since 1990--it has substituted 11 of the 30 stocks since then--change simply isn’t coming fast enough.

The oil industry has been fading in importance to the U.S. economy since 1980, but Dow Jones kept three oil stocks in the Dow until 1997.

Wal-Mart, the largest U.S. retailer, finally got a Dow slot in 1997, taking the place of Woolworth (now Venator). Why was that move so long in coming?

And with regard to tech, Dow Jones probably would prefer not to be reminded that it kicked IBM out in its early days, and added the stock back to the index only in 1979--missing most of IBM’s glory days.

Dow Jones respects tradition. But there is nothing traditional about the pace of change in the economy anymore, and in particular the speed with which the Internet is transforming the way we live, and how business is done.

Likewise, Dow Jones has always preferred to wait for companies to become established before considering them for the Dow index. But it seems inevitable now that corporate life cycles are going to be shorter, and that new industry leaders will arise much faster. Why shouldn’t the “premier” U.S. stock index reflect those realities?

Here’s a modest proposal: With just five substitutions, the Dow could become far more representative of the new economy. These five substitutions would mean pure tech and telecom stocks would make up about one-third of the 30-stock roster. That would still leave two-thirds of the index in other industry sectors Dow Jones deems important.

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Here are my five nominations for Dow membership:

* Cisco Systems. One can only hope this name is at the top of Dow Jones’ own list of possibilities. The premier computer networker, with $12 billion in sales last year, Cisco is building the backbone of the Internet worldwide--which is why its market capitalization (stock price times number of shares outstanding) is $470 billion, more than any company other than Microsoft.

If any tech stock belongs in the Dow, Cisco does.

* America Online. Public only since 1992, AOL dominates the online services market, with 21 million subscribers. Will it always wear that crown? Who knows, and who cares? For now, AOL is king, and that ought to be good enough for Dow Jones. And assuming the merger with Time Warner is a done deal, there’s even more reason for this titan to take its place among the Dow-30 elite.

* Yahoo. The No. 1 Internet portal, it’s the leading Net guide in terms of traffic and household and business reach. So what if sales were only $600 million last year? There’s a reason the market puts an $83-billion value on this company: If the future is the Net, Yahoo is a very important door to the future.

* Oracle. The new economy isn’t just about information; it’s about managing information. That’s the job of Oracle’s database software, about $9 billion of which was sold last year worldwide. The Dow could use a business-to-business e-commerce software play, and this is it.

* Nokia. As a growth industry, wireless communications is hotter than hot, and Nokia’s phones and other equipment (1999 sales: $20 billion) are a big reason why. Should it matter to Dow Jones that the company is based in Finland, not the U.S.? No more than it matters to wireless phone users.

Now, if those stocks were to get into the Dow, five would have to come out. I think there are five ripe targets for substitution.

Start with Eastman Kodak. It’s been in the Dow since 1930. That’s long enough. Whether or not Kodak’s struggle to re-energize itself is succeeding, film and other imaging products are less important to the new economy than many other tech products and services.

Philip Morris? One word: Cigarettes. This is not the future.

Aluminum giant Alcoa is a great company, but it’s still an old-economy business, and there are plenty of those in the Dow. Ditto for International Paper, whose earnings are expected to grow a slim 5% a year over the next five years.

As for Caterpillar: We’ll still need to move some earth every now and again. But the future is about moving digital impulses, not dirt.

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Retooling the Dow for the ‘New Economy’

The 30-stock Dow Jones industrial average is the world’s best-known market index, but its status may be threatened by the insurgent Nasdaq composite index. The technology-dominated Nasdaq has been far outpacing the Dow for most of the last decade. The problem: The Dow, despite numerous changes to its stock lineup, still doesn’t have enough “new economy” stocks. A look at how that problem might be fixed:

Goodbye, Good Luck?

These five Dow stocks are likely candidates for removal.

* Eastman Kodak

Business: Film, other imaging systems

* Philip Morris

Business: Cigarettes, food

* Alcoa

Business: Aluminum

* Caterpillar

Business: Earth moving equipment

* International Paper

Business: Paper, packaging

5 New Dow Picks

These technology leaders would be great substitutions.

* Cisco Systems

Business: Computer networking

* America Online

Business: Internet service

* Yahoo

Business: Internet portal

* Oracle

Business: Information management software

* Nokia

Business: Wireless communicationsSources: Times research, Bloomberg News, Value Line Investment Survey

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A New, Improved Dow 30

Here’s how the Dow Jones industrial average would look, by industry sector, after our proposed “make-over:” *

Technology

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Ticker Friday YTD Mkt. cap Stock symbol close change (billions) America Online* AOL $57.63 -24.1% $131 Cisco Systems* CSCO 137.44 +28.3 470 Hewlett-Packard HWP 138.63 +21.9 139 IBM IBM 108.00 +0.1 195 Intel INTC 119.25 +44.9 398 Microsoft IP 96.13 -17.7 500 Oracle* ORCL 75.00 +33.9 212 Yahoo* YHOO 158.00 -27.0 83

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Telecommunications

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Ticker Friday YTD Mkt. cap Stock symbol close change (billions) AT&T; T 54.56 +7.4 174 Nokia* NOK 221.00 +15.7 257 SBC Communications SBC 45.56 -6.5 155

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Financial services

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Ticker Friday YTD Mkt. cap Stock symbol close change (billions) American Express AXP 133.50 -19.7 60 Citigroup C 53.44 -4.0 180 J.P. Morgan JPM 110.75 -12.5 19

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Manufacturing/heavy industry

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Ticker Friday YTD Mkt. cap Stock symbol close change (billions) Boeing BA 35.94 -13.3 34 DuPont DD 50.75 -23.0 53 Exxon Mobil XOM 75.69 -6.1 262 General Electric GE 139.38 -9.9 457 General Motors GM 75.88 +4.4 47 Honeywell HON 45.50 -21.1 36 3M MMM 89.50 -8.6 36 United Technologies UTX 51.81 -20.3 25

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Consumer products/services

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Ticker Friday YTD Mkt. cap Stock symbol close change (billions) Coca-Cola KO 50.13 -14.0 124 Home Depot HD 54.50 -20.7 125 Johnson & Johnson JNJ 73.50 -21.2 102 McDonald’s MCD 32.31 -19.8 44 Merck MRK 57.50 -14.4 134 Procter & Gamble PG 88.44 -19.3 116 Wal-Mart WMT 52.63 -23.9 234 Walt Disney DIS 36.50 +24.8 76

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Dow average:

Friday: 10,367.50

YTD: -9.8%

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* Denotes stock to be added in “make-over” Source: Times research