A Better Index: The Diversified Dow 18

Meanwhile, two of the stocks that were ousted to make room -- Sears Roebuck(S) and ChevronTexaco(CVX) -- are up 104% and 60%, respectively. The other company removed at that time that's still publicly traded, Goodyear Tire and Rubber(GT), is down 55%.

More recently, on April 7, 2004, the managers of the Dow replaced International Paper(IP), Eastman Kodak(EK) and AT&T(T) with Pfizer(PFE), Verizon(VZ) and American International Group(AIG). That didn't work out so well, either. The exiting stocks have averaged a gain of 13.6%, led by a 37% advance in Eastman Kodak, while the arriving stocks have averaged a loss of 13.3%, led by a 31% decline of Pfizer. Whoops.

At this time of unusual uncertainty in the market, I'd like to step in to save the Dow from itself. And while I'm at it, let's review a method of playing the elder index I first introduced six months ago that involves paring back the laggards from the list and focusing on its success stories.

From an investment point of view, after all, we're usually better off choosing stocks that represent nothing so esoteric as the potential for the greatest earnings, revenue and price-appreciation growth over a reasonable time period -- say, six months.

An Even Better Dow

The last time I proposed using the Dow as a starter kit for a stock portfolio was, conveniently, six months ago. In an Aug. 19 column, I employed MSN's StockScouter system to cut the Dow 30 down to a list of seven potential outperformers.

And succeed they did. As a group, my Dow 7 has advanced 17.4% since Aug. 19, about two-and-a-half-times better than the 7% gain in the Dow 30. The roster was Altria Group(MO), +41%; McDonald's(MCD), +26%; ExxonMobil(XOM), +23%; Johnson & Johnson(JNJ), +18%; Citigroup(C), +11%, Honeywell(HON), +7%; and Procter & Gamble(PG), -4%.

My method of winnowing down the Dow 30 stocks now will be the same, except this time I'll include the two other major Dow indices: the 20-stock Dow Jones Transportation Index and the 15-member Dow Jones Utilities Index. I screened the MSN Money database only for the names in each group that were rated 8 or better by StockScouter, then removed stocks that appeared to be in long-term downtrends. Using data through the end of last week, 19 of these 65 stocks made the first cut. I then threw out the only stock with weak daily and weekly charts -- American International Group -- to arrive at the following 18-name list.

The Diversified Dow 18 Look for these stocks to outperform the broader market this year
	MSN StockScouter Rating	Feb. 4 Close	Daily Chart	Weekly Chart
Dow Industrials
Home Depot (HD:NYSE)	8	$42.42	Barely positive	Barely positive
Johnson & Johnson (JNJ:NYSE)	8	66.24	Positive	Positive
Altria (MO:NYSE)	8	67.00	Positive	Positive
Microsoft (MSFT:Nasdaq)	8	26.32	Barely positive	Basing
United Technologies (UTX:NYSE)	8	101.72	Positive	Positive
ExxonMobil (XOM:NYSE)	8	55.29	Positive	Positive
Dow Transports
J.B. Hunt (JBHT:Nasdaq)	10	$45.00	Positive	Positive
Yellow Roadway (YELL:Nasdaq)	10	56.31	Positive	Positive
CSX (CSX:NYSE)	9	39.45	Positive	Barely positive
CNF (CNF:NYSE)	8	46.49	Barely positive	Positive
Expeditors International (EXPD:Nasdaq)	8	56.31	Positive	Positive
Norfolk Southern (NSC:NYSE)	8	35.20	Barely positive	Positive
Dow Utilities
TXU (TXU:NYSE)	10	$74.86	Positive	Positive
PG&E (PCG:NYSE)	9	35.50	Positive	Positive
American Electric Power (AEP:NYSE)	8	35.65	Positive	Basing
Exelon (EXC:NYSE)	8	45.75	Positive	Positive
Public Service Enterprise (PEG:NYSE)	8	54.20	Positive	Positive
Williams Companies (WMB:NYSE)	8	17.64	Positive	Barely positive
Source: MSN Money

The six from the Dow 30 are, through pure coincidence, a nicely diversified group all by themselves, with one retailer, one drugmaker, one tobacco roller, one technology company, one defense contractor and one energy producer. Can't beat that.

The six from the transports index include two pure truckers, two railroads and two freight-forwarders. The six from the utilities index are primarily diversified via geography. There is one each from Texas, California, Illinois, New Jersey, Ohio and Oklahoma.

Whether the broad market succeeds or trades lower for the rest of the year, my bet is that these 18 will outperform the 30 Dow industrials as well as the other major market indices. If you'd like to propose another subset of the Dow 65 comprised of 20 stocks or less, please email them to me at [e-mail] along with your rationale, and write "Dow 65" in your email's subject line. I'll track them over the next six months.

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