DOCTORING THE DOW

By Daniel Kadlec

The Dow Jones industrial average checked in for cosmetic surgery last week and had four stocks liposuctioned from its bottom end. Is it time for a face-lift too? The "industrial" description is starting to look a little odd atop this svelte new body. Maybe it should be renamed Dow Lite.

Of course, no name change is really forthcoming. The Dow keepers--editors at the Wall Street Journal--have been softening the average's smokestack image for years, and no one seems terribly confused. Still, it's notable that today only half the Dow companies are true metal benders, a testament to sweeping changes in the economy during the past few decades.

The Dow has consisted of 30 stocks since 1928, and for most of this century most of those companies were in heavy industry, reflecting the times. But as we've moved from the industrial age to the technology-and-information age, the nature of industry has changed radically. In 1959, for example, manufacturing accounted for 28% of gross domestic product, vs. 17% today. Meanwhile, health care has grown from 3% to 11%, and financial services from 14% to 18%. Since the 1980s the Dow keepers have been scrambling to reflect such developments. So in the '80s American Express and McDonald's were added to the Dow as the likes of Johns-Manville and Owens-Illinois vanished. The early '90s saw Disney and J.P. Morgan added, while Navistar and USX got the boot. With the latest changes, which take effect this week, the Dow has morphed further from its heavy-industry roots: Woolworth, Westinghouse Electric, Bethlehem Steel and Texaco are being replaced by Wal-Mart Stores, Travelers, Johnson & Johnson and Hewlett-Packard.

It is debatable whether any 30-stock average can accurately reflect a diverse and changing economy. Most market pros prefer Standard & Poor's 500 index. But John Prestbo, markets editor at the Wall Street Journal, says he is committed to the Dow.

Interestingly, there isn't a dog in the bunch at this point. That's O.K. in an average of blue-chip companies, which are supposed to be the best of the best. But such doctoring can make an imperfect economy appear perfect. If this change had been made six years ago, the Dow would now be near 8000, not just passing 7000. Does that mean the Dow is going higher quickly? Not necessarily. Because adjustments are made for the higher prices of stocks added to the list, don't look for any immediate jump. And there's no guarantee that the newly added companies will continue to do well or that others on the list won't hit hard times. Prestbo warns, "Moving companies in and out of the Dow is not the same as a buy-sell decision." Consider IBM, which was dropped in 1939 but went on to post 29 stock splits and rise 21,843% before being added back in 1979.

In general, the new Dow recruits almost can't help having a positive impact, given the laggards they replace. The effect, however, will be felt only over time. The new stocks had not yet joined the list last Thursday, when the Dow fell 159 points, but their presence wouldn't have changed things much. When the Dow wants to drop, it drops--no matter how sleek the companies that make it up.

Daniel Kadlec is TIME's Wall Street columnist. Reach him at kadlec@time.com