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02/01/08
Conventional Wisdom Proven Wrong: Dow
Jones Stock Deletions Outperform Additions Over Time, According
to New Pomona College Research |
 |
New research published yesterday in the Journal of Wealth
Management found that stocks dropped from the Dow
Jones Industrial Average since 1928 have outperformed the
stocks that replaced them. The study, “The Real Dogs of the
Dow,” was conducted by the Pomona College research team of
Professor of Economics Gary Smith, Anita Arora (Class of
2006) and Lauren Capp (Class of 2006).
The researchers examined the 50 stock substitutions made
since the Dow expanded to 30 stocks in 1928. Rather than
look at each stock individually, they created two
portfolios: one of deleted stocks and one of the stocks that
replaced them. They excluded changes related to mergers,
acquisitions or name changes that did not involve the
addition of one stock and deletion of another.
Using the Center for Research in Security Prices (CSRP)
database, which was recently updated to include daily stock
returns prior to 1963, the researchers looked at daily
returns for all deletions and additions, for the entire
period from 1928 until December 31, 2006.
The results: “The Deletion portfolio beats the Addition
portfolio by a margin that is both substantial and
statistically persuasive. Over 250 trading days, daily
returns of .000591 and 0.000436 imply respective annual
returns of 15.9% and 11.5%.”
In comparing matched pairs of additions with deletions, in
32 of 50 cases, the deleted stock outperformed the added
stock for approximately five years after the substitution
date, before experiencing a more stable performance.
For the researchers, the findings proved the market’s
insufficient understanding of the principle of regression to
the mean. For the average investor, Professor Smith advises,
"There is no sure thing in the stock market, but
out-of-favor stocks, like those dropped from the Dow,
generally outperform whatever happens to be popular at the
moment."
Smith is the Fletcher Jones Professor of Economics at Pomona
College and the author of more than 50 articles and several
economics textbooks. A 2006 study that he co-authored also
disproved conventional wisdom finding that investing in
Fortune Magazine’s top 10 “most-admired companies” would
yield a better performance than the S&P 500. Smith earned
his B.A. in mathematics at Harvey Mudd College and his Ph.D.
in economics at Yale University.
Arora is a medical student at Dartmouth Medical School and
the Tuck School of Business. Capp is an analyst at
Cornerstone Research in NY.
Contact:
Gary Smith
Fletcher Jones Professor of Economics
Pomona College
Claremont, CA
Office Phone: 909-607-3135
E-mail at Gary.Smith@pomona.edu |
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