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By Chad Karnes

How good at stock picking are the people that sit aboard the Dow Jones Industrial Average's selection committee?

Not very good, if you look at the track record of their additions and subtractions to the Index over the last 20 years.

Case in Point: Back in September the Dow Committee made the announcement they were kicking out Bank of America (NYSE:BAC), Hewlett Packard (NYSE:HPQ), and Alcoa (NYSE:AA) from the Dow Jones Industrial Average. Predictably, most of Wall Street cheered the move, accepting it and assuming the Committee knows what it is doing.

Know what has happened since then? The stocks the Dow Committee dropped are now top performers and it's not a coincidence.

The Dow Committee's Track Record

Since being replaced in September, Bank of America is up 11%, Hewlett Packard is up 54%, and Alcoa is up an astounding 93%, far outperforming the three companies the Dow replaced them with.

Check out the chart below which was also included in our recently released July Profit Strategy Newsletter showing just how much the new stocks added to the Dow have lagged those companies dropped.

The companies dropped have gained almost 3x as much as those added. Following the Dow Committee's lead would have left you significantly underperforming.

Dow Committee Performance2

But the underperformance of newly added Dow stocks is nothing new as we expected such an event back in October when we broke down the latest Dow move.

Discussed in my public article, 'The Dow Committee Again Gets it Wrong' and also for our subscribers in our October Newsletter we backed up the proclamation, "If recent history is any guide, the Dow Committee is better at killing a stock's run than improving it".

Check out some of the recent Dow changes since 1997:

  • In 1997 the Committee added Hewlett Packard and Travelers (NYSE:TRV), both of which had marginal performance over the next five years, suffering greatly in the .com crash.
  • In 1999, after the tech boom had been in place for years, the Dow Committee added Intel (NASDAQ:INTC), Microsoft (NASDAQ:MSFT), Home Depot (NYSE:HD), and Southwestern Bell (NYSE:T), all of which were still down in price significantly five years later.
  • In 2004, AIG (NYSE:AIG), Pfizer (NYSE:PFE), and Verizon (NYSE:VZ) were added. Verizon was up only 4% five years later with Pfizer down 55%, and AIG down 98% five years later.

Dow Committee = Performance Chasers

All of these addition examples occurred only after significant price advances.

The Dow Committee rewards great price performance by adding the company to the Index, but its addition rarely precedes continued great price performance.

Only after Microsoft rose over 1,000% into 1998 did the Committee finally add it as a component. In 1999 Home Depot was added only after a 400% gain. In 2008 Bank of America was added to the Dow after its 50% five year performance.

Even one of the Dow Committee's good moves, Chevron, was up only 70% five years later compared to the 182% five year performance preceding its admittance into the Dow.

The Dow Committee has historically only added companies after they perform significantly well, more often than not occurring near the end of their performance trek. This is not a good sign for Nike (NYSE:NKE), Goldman Sachs (NYSE:GS), or Visa (NYSE:V), the latest three Dow component additions.

All three of these companies have also been rising significantly for years, up over a combined 175% since the 2009 lows, but it has taken the Dow Committee until now to add them to their Index. History suggests these three companies will not see near that kind of rise the next five years, with the odds high they will be lower in price as most recent examples show.

Disclosure: No positions

Link to the original post on ETFguide.com

Source: Own Nike, Goldman Or Visa? Here's Why You Should Worry