The Dow Just Drafted an All-Star Stock… But Don’t Buy It
|
Listen to this post
|
With sports, one of the most exciting events is draft season. It stirs up excitement as expectations run wild.
Choose the right player and you’ll hit the proverbial home run…
But as with anything, there are unknowns to be aware of. After the initial draft celebration dies down, two realities come to mind:
- First, a rookie can be hit-or-miss.
- Second, it can take a few years for a new player to truly develop into their potential.
Recently, the Dow made a new draft pick, adding a world-class company to the index: Amazon.com (AMZN)… and ousting Walgreens Boots Alliance (WBA).
Without question, Amazon is one of the best stock performers of all time, with a mind-numbing market cap of $1.81 trillion. Meanwhile, WBA has been falling for the better part of a decade… down more than 77% from its highs.
My initial response to this news was joy and excitement — I’m sure many investors had the same reaction. AMZN has been a star of the Nasdaq for years, and its performance is set to bolster the Dow.
But now that I’ve had a couple of days to digest this epic news, it got me wondering if Amazon is a screaming buy as it joins this storied index…
Do rookies of the Dow tend to crush markets… Or is it likely their draft stock is already priced to perfection?
Let’s settle that debate by looking at the box scores.
Today, we’re going to look back on how new Dow components typically perform in their “rookie year”… Chances are you’ll be surprised by the stats.
And as a bonus, you’ll see another choice worthy of consideration with your next draft pick.
What Amazon Joining the Dow Means for your Portfolio
News of Amazon joining the Dow is huge indeed. In fact, since the announcement on Tuesday night, AMZN has jumped 4.49%… easily doubling the S&P 500’s gain of 2.16%.Check it out:
This excitement doesn’t surprise me one bit. Anytime there’s a new move into a major index, it creates demand for the shares as funds that track the index are forced to buy ahead of the first trading day.
Additionally, there are all kinds of games that go on behind the scenes where some managers will wager on the new entrant ahead of the official inclusion date.
In other words, it’s common to see a positive stock reaction in the days after the headlines.
But let’s focus on the most prolific tracking fund for the Dow, the SPDR Dow Jones Industrial Average ETF (DIA). As of Feb. 22, the ETF had assets under management (AUM) of nearly $33 billion… not too shabby.
To find out if Amazon is a great buy today, I looked at prior new Dow entrants and tested their forward performance.
For my dataset, I went back to 2009 and found 13 additions. Then, I plotted the average one-month through 12-month forward returns.
To get the average performance, I gave an equal weight to each stock. And to make this study more interesting, I ran the same returns on the same dates for the DIA.
These comparisons will not only indicate how rookies perform against the veteran team, but it’ll also shed light on which is a better bet.
Also note that on some dates, multiple stocks joined the index. For simplicity, I treated those days the same as when just one stock joined.
The results are in. And they might be the exact opposite of what you expect.
Since 2009, newly added stocks to the Dow tend to vastly underperform the index itself, with:
- The average one-month-forward new entrant return falling 2.2%, vs. DIA dropping 0.9%
- At six months out, DIA gains 8.4% on average, vs. 2.3% for rookie stocks
- And 12 months later, DIA posts a market-beating return of 16.5%, trouncing new additions by more than double.
Also, notice that the “% Positive” data along the bottom is much higher in favor of the DIA ETF.
Now, before you think my advice is to tell you to sell Amazon… think again. But don’t be surprised if the retail giant underperforms the veteran team in the first year.
Like in sports, being an all-star rookie doesn’t always mean you’re going to have a breakout year. Often you have to learn the ropes, adjust to the game, and maybe even sit the bench.
We know Amazon is one of the highest-quality businesses in the world… but based on this data, its stock may already be priced to perfection.
Maybe the better data-driven swing to take is betting on the whole index via DIA — the veterans. History shows that’s the right move.
Which brings me to the important message. If your portfolio is stuck in the outfield, possibly running in place… now’s a great time to use software that can help you navigate in 2024.
TradeSmith has a bunch of tools available to help you make the most of this year.
But among the most powerful of these tools is our A.I.-powered stock forecasting algorithm, An-E.
This tool lets you see the most likely move for a stock, 21 trading days in advance, as determined by An-E’s advanced algorithm.
And the new-and-improved 2.0 version does even more than that — letting you exploit short-term changes in market conditions during this short window.
It all comes down to an ingenious new scoring system, designed to maximize gains from An-E’s predictions with less upfront capital.
With this new feature added to An-E, the profit-making potential of this tool goes vertical.
Thanks to your investment in TradeSmith Platinum, you’ve had access to An-E 2.0 for a while, with all the back-of-the-card stats — the Health Indicator and Volatility Quotient, as well as our big-league tools in Predictive Alpha Options — at your disposal.
If you haven’t already, check out the new Predictive Alpha Options Historical Zone Chart and see what An-E 2.0 can do for you.
Click here to visit your TradeSmith Finance platform.
Regards,
Lucas Downey,
Contributing Editor, TradeSmith Daily