9-10-13 5:21 PM EDT | Email Article

By MarketWatch


CHAPEL HILL, N.C. (MarketWatch) -- Getting booted from the Dow Jones Industrial Average might just be a blessing in disguise for Bank of America (BAC), Alcoa (AA) and Hewlett-Packard (HPQ).


That's because stocks deleted from the index often proceed to outperform those that replaced them -- in the current case, Goldman Sachs (GS), Visa (V) and Nike (NKE).


Just take Bank of America, which became one of the Dow 30 (DJI) on Feb. 19, 2008. Since then, its stock has produced a total return of minus-16.1%, annualized, according to FactSet. Altria (MO) and Honeywell (HON), the two stocks that were deleted from the Dow on the day Bank of America was added, have since then gained 14.8% and 10.3%, annualized, respectively.


To be sure, not all stocks added to the Dow proceed to underperform those that they replace. But, on average, they do.


One of the most comprehensive studies was conducted by Wharton University finance professor Jeremy Siegel, who measured the impact of all additions and deletions to the S&P 500 index since its creation in March 1957. He found that the deletions, on average, outperformed the additions.


This result is not as surprising at it might appear. Companies that are removed from the index are often down on their luck, while the firms chosen to replace them are, if not at the top of their games, at least leading their respective industries.


If the Dow were a portfolio, therefore, it would be guilty of often buying high and selling low.


Perhaps the most spectacular historical example of an ill-timed Dow deletion was the decision in 1939 to remove International Business Machines (IBM) from the benchmark. It was, of course, added back (and is today the index's most influential component) -- but not until years later.


According to Norman Fosback, editor of Fosback's Fund Forecaster, the Dow would today be more than twice its quoted level -- over 30,000, in other words -- had IBM not been removed from the Average in 1939.


The bottom line? Being deleted from the Dow might a blow to corporate executives' egos. But investors in the deleted stocks don't need to be particularly upset.


-- Mark Hulbert

-MarketWatch; 415-439-6400; AskNewswires@dowjones.com


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09-10-13 1721ET

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