The Dow Curse - Do Stocks Added to the Dow Underperform?

Is the so-called "Dow Curse" a myth or statistical-based reality? It has been called both. The Curse states that when a new company is added to the list of blue chip stocks that make up the Dow Jones Industrial Average, the company's stock begins significantly underperforming compared to the months prior to inclusion. The March addition of Apple (NASDAQ:AAPL) was expected to be a test of the Dow Curse, and so far, the Curse is winning.

Since its inclusion on March 15th, Apple has been essentially flat with growth in the 0.1-0.3% range. That is reasonably close to the overall Dow performance in the same period, but well below the 13% growth in the three months prior to inclusion. Conversely, the stock that Apple replaced, AT&T (NYSE:T), has risen approximately 4% in the same three months.

The Dow Curse does not always strike, but it has a disproportionate number of hits. Sixteen different firms have joined the Dow since 1999, and fifteen of those have had an average share price increase of 1% during their first six months in the index. For comparison, in the six months prior to inclusion, the share price of all sixteen firms was up by 11% on average.

Expand that analysis to a year in either direction, and the comparison gets worse. The stocks rose 25% on average in the twelve-month period before inclusion and fell 7% one year after. In fairness, Bank of America (NYSE:BAC) is responsible for a huge amount of that average. In an unlucky bit of timing, it was included in February 2008, almost exactly a year before the low point of the housing crisis and financial meltdown in 2009.

There are two compelling reasons why the Dow Curse makes sense.

Transition – Typically, when a company reaches the success level to be included in the Dow, it has reached that status through solid regular stock performance and frequent gains. By the time most companies reach blue chip status, they are providers of solid returns but not the large growth returns of previous months or years. They transition into a more cyclical stock. In Apple's case, there is a little bit more at stake. Their model is strongly based on continuing innovation, unlike more traditional companies like American Express (NYSE:AXP), Coca-Cola (NYSE-KO), General Electric (NYSE:GE), and Wal-Mart (NYSE:WMT). The recent release of the Apple Watch has been less than overwhelming, and without a big hit in the next cycle, people may begin to question if Tim Cook can keep the Apple innovation cycle rolling. It is hard to argue that the Dow Curse is in any way related to disappointing Apple Watch sales, but the timing does fit nicely.

Psychology – The markets are still subject to herd mentality, and it is possible that concerns about a Dow Curse influence the thinking of some investors. Expecting a drop, they act accordingly and make the Dow Curse a self-fulfilling prophecy. If you are used to investing in Apple and expecting the continued high growth rate, it does not take much of a dip or flat period to shake your faith. However, if you are a long-term investor it is hard to see Apple as a bad buy — FactSet reports that 69% of a group of analysts that regularly cover Apple are bullish on future prices.

In short, you cannot depend on the Dow Curse to be 100% accurate, but it is compelling enough to analyze a new entrant to the Dow more closely — and potentially use that advantage as an opportunity to pick up solid stocks at a temporary bargain price. Think about profiting from the curse the next time the Dow Jones opens its doors to a new member.