What It Means to Be a Dow Component

A recent memo from Hewlett-Packard CEO Meg Whitman to HP employees reads, in part, "I hope every HP employee took today's announcement personally."

She was referring to the announcement that HP would no longer be a member of the renowned Dow Jones Industrial Average . Whitman also wrote that being removed was a "blow to our brand" and that the move showed that many still didn't believe the company could turn itself around.

What is the Dow?
The Dow is the blue-chip stock index made up of 30 stocks that many investors consider to be safe, reliable stores for their money. Among the reasons for their perceived safety are their history and proven longevity to adapt and change to different economic conditions, their ability to make themselves relevant and reinvent their products, their financials and strength of their balance sheets, and the position they hold in their respective industries. The list could go on and on, but the point is that these are stable companies. Unlike HP, they aren't in turmoil or struggling. And if they do find themselves in trouble, they're given time to rebound and turn things around before they get kicked to the curb. HP had been in the Dow since 1997 and is now two years into a turnaround plan that has yet to show any meaningful progress.

But HP wasn't the only company the Dow sent packing for failing to meet its high expectations. Like HP, Alcoa has been struggling for years as the price of aluminum has tanked. And although Bank of America has rebounded since the financial crisis, there are certainly other banks doing a little better. 

Not only though are the Dow components supposed to be strong businesses, but they're also supposed to represent the American economy. The index was intended to be a way for investors to quickly look at one number, one ticker, one chart, and understand what's going on with the U.S. economy. So the components need to be companies that show strength, as well as dominance within their industry, and all for an extended period of time.

Take Nike , one stock joining the Dow during the recent switch. The company has been around since 1964 and is one of the foremost leaders, if not the leader, in sports athletic clothing, equipment, shoes, and accessories. One could argue that Nike should have been put in the Dow years ago, but the other side of the coin is that Nike may have not proved that it could maintain its market position in the fashion industry, which changes not every year, but every season.

Some have argued that Google or even Apple should be part of the Dow, but they lack the longevity and history the Dow demands from its components. Both companies have strong financials and impressive balance sheets, and they're certainly among the top dogs in their markets. But Google has been around since only 1998, and Apple wasn't a dominant player in the technology industry until the iPod rolled out in 2001.

Wall Street and Main Street look at the Dow components the way fans view sports hall-of-fame inductees. You can't just be a great pitcher one or two seasons, a quarterback who wins one Super Bowl, or the guy who makes one last-second three-point shot -- you have to be the guy who does those things consistently, year after year. You have to be the guy everyone else wants to be. Being a Dow component is a similar thing, but while a career in sports may last only a decade or so, to be inducted into Wall Street's hall of fame, a company needs to be on top of its game for a lot longer than that. That's no easy feat, but that's also why investors tend to feel comfortable that the Dow components are dependable, proven winners they can put their investing dollars into.

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The article What It Means to Be a Dow Component originally appeared on Fool.com.

Fool contributor Matt Thalman owns shares of Bank of America, Apple, and Google. Check back Monday through Friday as Matt explains what caused the Dow's winners and losers of the day, and every Saturday for a weekly recap. Follow Matt on Twitter: @mthalman5513The Motley Fool recommends and owns shares of Apple, Bank of America, Google, and Nike. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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