Dow tweaks recipe by added Kraft

10/6/2008


Last month, Kraft Foods ($33; NYSE: KFT) replaced American International Group ($3; NYSE: AIG) in the 112-year-old Dow Jones Industrial Average — a change spurred by the government’s $85 billion bailout of the troubled insurance behemoth.

While there are no specific criteria for membership in the Dow Industrials, Kraft’s selection adds a defensive name and marks the first pure-play food producer in the Dow in more than 20 years. So far in 2008, Kraft has gained 3.1%, versus a decline of 15% for the average stock now in the index.

The loss of AIG leaves the Industrials underweight in financials relative to the broader S&P 500 Index. Financials represent 10% of the Dow Industrials, the average’s fifth-largest sector. In contrast, the financial sector has the second-highest weight in the S&P 500, accounting for 16% of the index. The addition of Kraft makes consumer staples the Dow’s second-leading sector at 15%, well above the S&P 500’s 12% weighting.

The Dow Industrials earn solid Quadrix® scores. Based on weighted averages for the 30 holdings, the portfolio has an Overall score of 73, versus 68 for the S&P 500. The Industrials earn particularly strong scores for Value (64) and Quality (74). We also considered the percentage of assets in each portfolio with Overall scores above 80, a statistic that more closely corresponds to the way we use Quadrix. Some 53% of the assets in the newly constituted Dow Industrials earn Overall scores above 80, compared to roughly 38% for the S&P 500.

While the Dow stacks up well in Quadrix, not all of its individual components look attractive. Consider Kraft, which earns a subpar Overall score of 39. Investors seeking exposure to well-known megacap stocks from the Industrials should consider the two top picks reviewed in the following paragraphs.

Often overlooked amid Wall Street’s latest upheaval and dizzying fluctuations in oil prices is Chevron ($82; NYSE: CVX) — profitable, stable and flush with cash. Per-share-profits have increased in each of the last five years, and the financially strong oil giant has increased its dividend in each of the last 21 years, most recently a 12% hike in May. In a tightening credit environment, Chevron enjoys strong cash flow, which it is plowing back into the company at record levels.

During the first half of 2008, Chevron’s per-share profits grew 14% to $5.38 on 45% sales growth. Profits at the exploration-and-production unit nearly doubled. But downstream operations, which include refining and marketing, lost money as high energy prices crimped margins.

Chevron was added to the Dow in February, marking the company’s third appearance in the index. Chevron or its predecessor companies were part of the average in 1924 and 1925 and again from 1930 to 1999. Chevron’s Overall score of 94 is driven by high Value (85) and Quality (89) scores. Chevron is a Buy and a Long-Term Buy.


IBM ($117; NYSE: IBM) shares have risen 9% so far this year. The company topped consensus profit estimates by at least 8% in the March and June quarters and raised its quarterly dividend 25% in April. A diverse business mix insulates IBM against weakness in portions of the economy. More than 60% of sales come from overseas, a percentage likely to increase as IBM expands its presence in emerging markets.

Although hardware sales have slowed in recent quarters, IBM continues to grow the software and service divisions. The company controls 10% of the global market for technology services. IBM helps clients reduce costs and improve productivity, services likely to remain in demand during market downturns. Foreseeing a surge in corporate demand for mobile communications, IBM has strengthened partnerships with wireless carriers AT&T ($28; NYSE: T) and Sprint Nextel ($6; NYSE: S).  As more customers work from remote locations, IBM is positioning itself to satisfy demand for accessing e-mail and data using handheld devices. IBM is a Focus List Buy and a Long-Term Buy.

A TALE OF FOUR PORTFOLIOS
Dow
Industrials
S&P 600
Index
S&P
MidCap
400
S&P
SmallCap
500
Weighted Average Quadrix Score *
Overall
73
68
64
62
Momentum
58
56
58
55
Value
64
60
54
52
Quality
74
71
64
62
Financial Strength
68
67
61
61
Earnings Estimates
42
44
53
51
Performance
61
55
61
66
% of Assets with Overall above 90
18
14
13
12
% of Assets with Overall above 80
53
38
30
27
Sector Weights (%)
Consumer Discretionary
9
8
13
14
Consumer Staples
16
12
4
4
Energy
12
13
7
7
Financials
10
15
18
19
Health Care
9
13
13
14
Industrials
20
11
15
17
Information Technology
15
16
14
16
Materials
5
4
7
4
Telecom Services
4
3
0
0
Utilities
0
4
8
5
* Quadrix® scores are percentile ranks, with 100 the best.

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