Dow Picks Kraft

September 22, 2008

When I heard that Dow Jones had selected Kraft Foods to replace AIG in the Dow Jones Industrial Average, I couldn't believe it.

Kraft (NYSE: KFT)?  I mean, I love mac 'n' cheese as much as the next guy, but ... Kraft? 

What about the 14 companies I highlighted as likely candidates for the Dow? What about my two favorites—Amgen and Wells Fargo? 

I really thought Amgen would get the nod. Biotech represents an increasingly important part of the American economy, and picking Amgen would show that Dow Jones was embracing the future of American commerce and not just the well-established past.

And Wells Fargo? What a statement that would have been about the continued importance of the Financial sector in today's economy! Wells Fargo is a well-run bank, and probably deserves a place in the Dow 30. It would have been nice to look past the headlines and recognize that.

Still, now that the initial shock of being wrong has worn off, I have to admit: It is hard to argue with the selection of Kraft. "Food" is a pretty basic category—pretty important to our day-to-day lives—and there were no food companies in the Dow.

Why did I miss that? I didn't look far enough down the market capitalization tables. With a market cap of just $50 billion, Kraft is not even among the 100 largest companies in America. I thought Dow Jones would look bigger than that, but clearly, I was wrong. I should have known better: There are a half-dozen smaller companies already in the Dow, including GM, 3M and American Express.

In a way, the selection of Kraft is a reminder that the Dow Jones Industrial Average is closer to Rob Arnott's Fundamental Index family than it is to straight, market capitalization indexes. The Fundamental Indexes use a "Main Street" approach to selecting and weighting companies, rather than a "Wall Street" approach: practically speaking, that means they use measures like revenues and book value rather than market cap to choose components.

Consider Kraft and Amgen. Despite having a market cap of just $51 billion, Kraft has an enormous "Main Street" presence: It has revenues of $41 billion, 1 million employees and an important presence in the lives (and cupboards) of millions. Amgen, in contrast, has a market cap of $64 billion, but revenues of just $14 billion and employs just 17,400. Not surprisingly, Kraft is the 27th-highest-weighted company in the FTSE RAFI 1000, while Amgen ranks 49th.

The truth is, there is substantial overlap between the DJIA and the FTSE RAFI U.S. 1000: 19 of the top 30 components in the FTSE RAFI 1000 are also in the DJIA, including all of the top 10 components.

So what are the largest holdings in the FTSE RAFI 1000 that are NOT included in the Dow?

ConocoPhillips and Wells Fargo.

See: I knew WFC was a good guess. Maybe next time.

 

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