Assessing Stock Performance Following Dow Shakeups

A contrarian stance may not be the best approach

Senior Quantitative Analyst
Aug 26, 2020 at 8:00 AM
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There was a substantial change to the companies making up the Dow Jones Industrial Average (DJI) this week. (CRM), Amgen (AMGN) and Honeywell (HON) are now in the Dow 30, while Exxon Mobil (XOM), Pfizer (PFE) and Raytheon Technologies (RTX) got kicked out. Looking at this from a sentiment perspective, it could mark the top in expectations for these three new stocks, while it may also indicate a low point in attitudes for the three stocks that got knocked out. From that point of view, then, a contrarian would lean towards selling the new stocks in the index, and buying those that were removed from the Dow. Below, I will be looking at whether the numbers support this theory or not.

New Dow Stocks

Since 1997, 23 stocks have joined the Dow. I looked at how those stocks performed after officially being added to the index -- the table below summarizes those returns. The second table is for comparison, and it shows what the returns looked like had you purchased the index instead of individual stocks.

Based on the theory above, sentiment on these stocks would have been at a high point, and I would have expected underperformance from this group. However, whether the numbers support this theory or not varies. A month after being added, only 35% of the stocks were positive, and only 39% of the stocks beat the Dow Index. The stock fell an average of 1%, but the Dow fell even more on average, by 1.36%. Looking at returns a full year after being added, the stocks only gained an average of 1.23%, with just 52% of those stocks being positive.

If you had purchased the index, you would have averaged a 4.2% gain per trade, with 78% of the returns positive. Additionally, only 43.5% of the stocks beat the index over the next year, with the 12-month returns supporting my theory. The time-frames in the middle, however, do not support this theory. Roughly 65% of the stocks beat the index over the next three months. By purchasing the stocks, you would have gained 7.1% over the next three months, and 6.8% over the next six months, compared to the Dow’s 4.2% and 2.7% returns, respectively.

Stock Returns After Dow Addition 

Below is the full list of stocks that have joined the Dow since 1997. The last stock added to the index was Dow Inc. (DOW), the chemical company, which joined the Dow the same day it was spun off from DowDuPont. The stock has not performed very well since then. Its 50% loss over the next year was worse than the Dow Indexes 18% loss, as it was early in the recovery from the coronavirus crash. Before that addition, Walgreens Boots Alliance (WBA) joined the Dow in the summer of 2018. That stock fell over 20% in the next year.

Stocks Added to Dow 97

Kicked Out of the Dow

Next, I will be looking at stocks that got kicked out of the Dow 30 Index. The theory is that these stocks would outperform, because getting kicked out of the most popular index usually implies negative sentiment toward the stock.

One reason a stock leaves the index is because the company no longer trades, either because it merged with another company or it went bankrupt. That is why there are fewer stock returns in this table than in the new additions table. As you can see below, it is a good thing I ran the numbers to test my theory. These stocks have not outperformed the index. In fact, they have performed terribly, especially in the short term. A month after officially leaving the Dow, these stocks averaged a huge loss of over 7%. Barely a quarter of the stocks beat the Dow over the next month. And going out a full year, these stocks averaged a loss of 3.14%, with only 40% beating the index.

Looking at the second table shows the returns if you had purchased the index instead. We are able to see that those stocks were kicked out when the index was going through some tough times. The index itself averaged a loss over the next year. Nonetheless, you would have been much better off investing in the index than the stocks that left.

Dow Comparison Returns

Finally, here is an individual list of stocks that left the Dow. DuPont De Nemours (DD), which became an independent company after spinning off Dow Inc., did even worse by falling about 58% over the next year. General Electric (GE), the stock that got replaced by WBA in 2018, also did horribly over the next year, falling over 20%.

Dow Kicked Out 97 2


All in all, the data does not support the contrarian theory mentioned above. Both the stocks that were added and removed underperformed the general index, considering the longer term 12-month returns. Looking at the dates of those changes, and judging by the comparison returns, it seems the major shakeups have tended to happen ahead of volatile times. Perhaps this is foreshadowing, but then again it would be difficult to top the volatility we have seen over the past several months (famous last words).



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