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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.

Gary Smith
Fletcher Jones Professor of Economics
Pomona College
Claremont, CA
Office Phone: 909-607-3135
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