The Dow Jones Industrials Is Changing
The Dow Jones Industrials (Average) or DJIA is changing. This happens periodically due to mergers or acquisitions, changes in company operations, and changes in the U.S. economy. The list is not static, and it is continuously changing. The new components will be Salesforce (CRM), Honeywell International (HON), and Amgen (AMGN). The three stocks that are being replaced are ExxonMobil (XOM), Pfizer (PFE), and Raytheon Technologies (RTX). The changes will go into effect before the market opens on Monday, August 31st.
First some history on the Dow Jones Industrial Average, which is also referred to as the Dow 30 before we discuss why it is changing. The Dow Jones 30 refers to an index of 30 blue-chip stocks that was created by Wall Street Journaleditor Charles Dow in 1896. It is the second oldest index after the Dow Jones Transportation Average. The name is derived from Charles Dow and his business partner Edward Jones. The index was created to track the market performance of leading industrial stocks in an era when information flow was limited. Initially, there were 12 companies in the index. In 1928 the index was expanded to 30 stocks, which is the number today. The index is price weighted. This means that stocks with higher share prices are given greater weight in the index. It is calculated as the sum of the prices of all 30 companies divided by a factor. The factor, which is referred to as the Dow Divisor is adjusted for stock splits and dividends.
Today, the Dow Jones Industrial Average is chosen by committee. The index is maintained by the S&P Dow Jones Indices, which is majority owned by S&P Global. The index does not include transportation and utilities, which have their own indices. Reportedly, to be considered for the Dow 30, a company must meet the following criteria:
- Must be incorporated and headquartered in the U.S.
- Generate the majority of its revenue from the U.S.
- Help make the Dow representative of the overall U.S. economy
- Attract a large number of investors
- Demonstrate sustained growth
- Have an excellent reputation
The 10 stocks with the highest yields are referred to as the Dogs of the Dow.
Why is the Dow Jones Industrials Changing?
Now, why is the Dow Jones Industrials changing? From the press release by the S&P Dow Jones Indices:
“The index changes were prompted by DJIA constituent Apple Inc.’s decision to split its stock 4:1, which will reduce the index’s weight in the Global Industry Classification Standard (GICS) Information Technology sector,” a statement read. “The announced changes help offset that reduction. They also help diversify the index by removing overlap between companies of similar scope and adding new types of businesses that better reflect the American economy.”
Due to Apple’s (AAPL) 4-for-1 stock split, its ranking will drop from No. 1 to No. 16. Recall, that the Dow 30 is price weighted. So, Apple’s weighting in the average will fall from 11% to just 3%, according to S&P Dow Jones Indices. I do not expect it to stay there but with a $2 trillion market capitalization, it will take some time to climb the rankings.
So, that is why the Dow Jones Industrials is changing. I don’t follow the Dow 30 in any great detail However, there are some small investors that follow the Dogs of the Dow investing strategy. In addition, all of the Dow 30 pay a dividend with the exception of Disney (DIS) and Boeing (BA) due to suspensions. Salesforce will be the exception as it does not pay a dividend currently.
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List of Dividend Challengers in 2020
I updated my article on the List of Dividend Challengers in 2020. The Dividend Challengers as a group were hit hard by the coronavirus pandemic. The Dividend Challengers are companies that have raised their dividend for a minimum of 5 years but no more than 9 consecutive years. Once a stock raises the dividend for 10 years it becomes a Dividend Contender. Once a stock reaches 25+ consecutive years of dividend increases it graduates to Dividend Champion status.
The number of stocks on the Dividend Challengers list has dropped dramatically. There were 463 companies on the list at the beginning of the year. Currently, there are only 350 companies on the list, an almost 25% reduction. The reason is simple though, it does not take much effort to reach 5 years of dividend growth. However, it is much harder to get to 10 years due to the business cycle. Some companies lack quality meaning their cash flows or balance sheet are not strong. When sales and operating income drop this inevitably leads to a dividend cut or suspension.
There were many deletions and a few additions. Take a look at the updated list of Dividend Challengers in the article.
Coronavirus Dividend Cuts and Suspensions List
I updated my coronavirus dividend cuts and suspensions list this past Wednesday. The number of companies on the list has risen to 354. We are over 10% of companies that pay dividends having cut or suspended them since the start of the COVID-19 pandemic. The number of companies on the list continues to rise each week.
This past week there were four companies added to the list, but I also included one company that I had previously missed. The four new companies were Xperi Holding (XPER), Brigham Minerals (MNRL), Prudential PLC (PUK), and Marine Petroleum Trust (MARPS).
The one company that I missed previously was ARMOUR Residential REIT (ARR).
There was an interesting study on dividend suspensions published on June 16, 2020. The article was titled “Dividend Suspensions and Cash Flow Risk during the Covid-19 Pandemic” by Professors David Pettunuzzo (Brandeis), Riccardo Sabbatucci (Stockholm School of Economics), and Allan Timmermann (UCSD). The authors examined the effects of the COVID-19 pandemic on a firms’ decisions to suspend its dividend. They also estimated a model that quantifies the effect of suspensions on dividend growth in aggregate. The researchers found that businesses with high leverage and low profitability were more likely to have suspended their dividends during the coronavirus pandemic. Importantly, the researchers also found that businesses with largest negative stock returns before the dividend announcement were more likely to have suspended their dividend. The last interesting point was that dividend suspensions had a large impact on expected future dividend growth and also helped predict declines in measures of economic activity.
I highlight one table from the research paper that shows the number of dividend suspensions by industry classification for both the Great Recession and the COVID-19 pandemic. Dividend suspensions were high in the Consumer Non-Durables, Consumer Durables, and Finance sectors during the Great Recession. On the other hand, dividend suspensions are high in Manufacturing, Oil, Gas, and Coal; Wholesale, Retail and Some Services; and Other sectors during the pandemic. Interestingly, there were zero dividend suspensions in the Utilities category (to date) during both time periods. Utilities provide an essential service.
Pretty much the research paper emphasizes one of the core points I make in my blog, which is that quality matters in dividend growth investing.
Stock Market Volatility – CBOE VIX
The CBOE VIX finished this week slightly higher than last week at approximately 30. Since bottoming a couple of weeks ago volatility is now trending up. It still remains elevated relative to the long-term average. The long-term average is approximately 19 to 20. In my opinion there are two drivers of volatility besides the number of new infections: unemployment and federal stimulus.
The number of weekly new unemployment claims is still elevated at over 1 million. This was the second week in a row of claims over 1 million. The job market is still tough for many people. Several companies have announced permanent layoffs of workers that were only previously temporarily furloughed. This includes large cuts at companies like MGM Resorts International (MGM), The Coca-Cola Company (KO), Stanley, Black & Decker (SWK), Salesforce (CRM), American Airlines Group (AAL), Bed, Bath & Beyond (BBBY), Estee Lauder (EL), Boeing (BA), Raytheon Technologies (RTX), and others.
Further, there has been little to no progress on the next round of stimulus. The House passed a roughly $3.4 trillion stimulus called the Heroes Act about 15 weeks ago after the CARES Act. This bill was never taken up the by the Senate. The administration is advocating a $1 trillion stimulus. At some point I suspect that they will meet in the middle but that has not yet happened.
In the meantime, several Executive Orders were signed. But they do not add more money to stimulus, and some are seemingly ineffective. Businesses have indicated that they will continue to collect payroll taxes for Social Security and Medicare as they must still be paid by employees or employers by April 2021 according to recent IRS guidance. Some states are opting out of the extra $400 per week (or $300 per week) of unemployment benefits and the amount of money is small in aggregate and will not last long at only about three weeks. Further, only five states have started issuing the extra unemployment benefits. The order about evictions does not stop evictions but only directs agencies to discuss it. The order extending student loan deferrals are only for those being held by the Department of Education. It does not cover these being held by private firms.
Ultimately, the reality is that new federal stimulus will need to be passed by Congress and signed into law.
Fear & Greed Index – Dow Jones Industrials Changing
I also track the Fear & Greed Index. There are seven indicators in the index. They are Stock Price Breadth, Put and Call Options, Stock Price Strength, Junk Bond Demand, Safe Haven Demand, Market Momentum, and Market Volatility.
The current reading is now at 78, which is in Extreme Greed. This is the up eight points from last week. After being in Greed for six straight weeks, the index has now entered Extreme Greed.
Note that this index rarely stays above 60 for an extended period of time. Typically, once this index goes over 60 there is a move down. However, this is not a hard and fast rule. Sometimes the index does go higher to even over 80. Historically, once the index goes over 80 it comes down pretty fast.
A lot of the increase is due to new highs by many tech stocks as well as momentum in the S&P 500.
Market Valuation – Dow Jones Industrials Changing
The S&P 500 is trading at a price-to-earnings ratio of 30.2X and the Schiller P/E Ratio is at about 32.3X. These have ticked up further since last week. Note that the long-term mean of these two ratios are 15.8X and 16.7X, respectively. I continue to believe that the market is largely overvalued at this point. We are starting to get to overvaluation levels seen during the dot com boom. We all know how that turned out. In my opinion caution is warranted for investors.
S&P 500 PE Ratio
Shiller PE Ratio
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