Are Dow Stocks Better Than S&P Stocks?

By Sham Gad | April 19, 2012 AAA

An interesting event is happening with respect to U.S. stock markets lately: the Dow Jones Industrial Average (DJIA) is having days where it is significantly outperforming the S&P 500. Over the past 10 years, the DJIA has outperformed the S&P 500 and may serve as a better barometer of overall U.S. market performance. Over the past 10 years, the DJIA is up roughly 29% and the S&P 500 is up 25%.

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Not a Fair Comparison
Realistically, one shouldn't expect a similar result from the Dow Jones Industrial Average, which consists of 30 stocks, and the larger S&P 500. To be sure, the DJIA has been modified over the years so that the index is actually a decent proxy for the U.S. market. In addition to typical industrial names like Caterpillar (NYSE:CAT), the Dow also includes leading technology names like Microsoft (Nasdaq:MSFT). However, the S&P 500 includes all of those plus important names such as Visa (NYSE:V), which is not included in the DJIA but is nonetheless a very strong part of the U.S. and global economy.

Valuation Matters
Ultimately, valuation matters and drives stock prices higher or lower. Coming out of the recession the market surge led a magnificent run up in lesser quality smaller cap issues. By definition, the DJIA is made up of 30 of the largest and strongest companies that collectively produce a decent barometer of overall industry performance. Today's big cap companies seem to offer the most attractive upside from a valuation standpoint. Dow component Chevron (NYSE:CVX) trades for less than eight times earnings and yields 3.2%. The price of oil is in a really good place for oil companies today, and that will likely mean significant profits for Chevron. Verizon Communications (NYSE:VZ) is benefiting from pricier data plans as consumers consumer more data on devices like smartphones and tablet computers. With shares yielding 5.2%, conservative income-seeking investors will be attracted.

SEE: Why Dividends Matter

The Bottom Line
Ultimately, comparing the performance between the Dow Jones Industrials and the S&P 500 is not a meaningful exercise. For one, the DJIA is a price-weighted index, so strong performance from high price stocks will have an abnormal effect on returns. What matters is the valuation of companies, and at the moment, many of the DJIA components, who also belong to the S&P 500, offer the best risk/reward profile.

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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

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