The Last Thing You Should Do Is Buy The 3 New Dow Stocks

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 |  About: Goldman Sachs Group Inc. (GS), V, Includes: NKE
by: Special Situations and Arbs

One of the biggest pieces of news last week was the changes coming to the Dow Jones Industrial Average. Hewlett-Packard (NYSE:HPQ), Alcoa (NYSE:AA) and Bank of America (NYSE:BAC) are heading out while financials Goldman Sachs (NYSE:GS) and Visa (NYSE:V) along with Nike (NYSE:NKE) are moving in. In a Seeking Alpha article on Wednesday, Benzinga discussed the additions and reasons for the changes, one of which is that the Dow is a price weighted index and low priced stocks serve little purpose in the index.

The changes will go into effect next Monday, September 23rd.

So should the three newcomers be bought? History says NO. At least not for a month anyway.

In the past decade nine stocks have joined the Dow. If an investor would have bought those stocks on the open on their very first day in the Dow they would have eight losses and one gain of a single penny a month later.

No Quick Start Here

NAME OF STOCK ADDED TO DOW DATE ADDED PRICE ADDED PRICE 1 MONTH LATER PERCENTAGE AFTER 1 MONTH
United Health Group Inc. (NYSE:UNH) 9/24/12 56.08 55.92 -0.2%
Cisco Systems (NASDAQ:CSCO) 6/8/09 19.74 18.13 -8.2%
The Travelers Companies (NYSE:TRV) 6/8/09 42.69 39.07 -8.5%
Kraft Foods (was KFT now MNDZ) 9/22/08 34.26 28.18 -17.7%
Bank of America Corp. (BAC) 2/19/08 43.18 38.56 -10.7%
Chevron Corp. (NYSE:CVX) 2/19/08 84.39 81.89 -3.0%
Pfizer Inc. (NYSE:PFE) 4/8/04 35.99 36.00 Even
Verizon Communications (NYSE:VZ) 4/8/04 37.60 36.35 -3.3%
American International Group Inc. (NYSE:AIG) 4/8/04 76.90 69.75 -9.3%
AVERAGE LOSS -6.77%
Click to enlarge

Source:Yahoo Finance (Prices for 1 Month Later column used are the closing prices of the stocks one month after being added to the index)

Some additional facts of note:

  • The last stock to join the Dow, UNH, while only having a modest first month decline, was off 2.9% after 6 months in the index.
  • At some point during its first month in the Dow, BAC was down a whopping 21% and KFT was down a staggering 25.4%.

The sample size is large enough to take notice. Five of the above nine finished down more than 8 percent in that first month. Some of those stocks entered the Dow in bull markets, some in bear markets. Some in traditionally strong seasonal periods, some in weak ones. The financials struggled as did the technology and healthcare firms. I bet even Tesla (NASDAQ:TSLA) would have a tough month if they got the Dow call.

So why does this happen?

It's a case of sell the news. Most of the rookie Dow stocks get a decent-sized bump when the announcement is made which is usually a few days before the changes take place. In addition, the Dow often waits until conditions seem perfect for a company before including them. And that can be a sign of a short-term top.

How to make money from this data?

  1. For those who want to buy the "Big Three" now. WAIT for better prices.
  2. For those who own any of the "Big Three" already, depending on one's individual tax situation, either sell the stock or sell slightly in the money or at the money covered calls against the equity position.
  3. Short the stocks.
  4. Perhaps a more reasonable way to bet against the "Big Three" short term would be to buy a short term slightly in the money or at the money put option.

So far in 2013 Visa has gained 21.6 percent, Goldman 24.6 percent and Nike 31 percent. All three are handily beating the Dow's 14.9 percent increase. Some may call the Dow's upcoming changes buying high and selling low.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in V, GS, NKE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may buy Put options or sell call spreads on one or more of the three incoming Dow stocks this week