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The Dow, explained

Ask the Fool

Published: January 7, 2020

Q: What's "the Dow"? -- F.S., Dublin, California
A: Its full name is the Dow Jones Industrial Average, and while it's often seen as representing the entire United States stock market, it's actually an index of just 30 companies.
The Dow was established back in 1896 with 12 companies. These companies included General Electric; U.S. Leather (now dissolved); U.S. Rubber (now Uniroyal, part of Michelin); American Tobacco (broken up due to antitrust concerns); Laclede Gas (now Spire); and Tennessee Coal, Iron & Railroad (acquired by U.S. Steel).
Over the years, many companies have been added to or removed from the index. The Dow today consists of 3M, American Express, Apple, Boeing, Caterpillar, Chevron, Cisco Systems, Coca-Cola, Walt Disney, Dow (the chemical company, unrelated to the index), Exxon Mobil, Goldman Sachs Group, Home Depot, IBM, Intel, Johnson & Johnson, JPMorgan Chase, McDonald's, Merck, Microsoft, Nike, Pfizer, Procter & Gamble, Travelers Companies, United Technologies, UnitedHealth Group, Verizon Communications, Visa, Walmart and Walgreens Boots Alliance.
The Dow first closed above 1,000 in 1972, and it topped 28,000 in November. It has been criticized for being a "price-weighted" index, with its value based on its components' stock prices rather than their market values or some other factor. Here's why that's problematic: Pharmaceutical companies Merck and Pfizer both recently sported market values close to $210 billion. But Merck's stock price, recently near $89, gives it much more influence in the index than Pfizer, with its recent stock price near $38.
Q: What's an investment's "real" return? -- W.T., Jefferson City, Missouri
A: It's a gain that has been adjusted for the effect of inflation. For example, if your portfolio gains 8% in a year and inflation for that year is 3%, your real return would be 5%. It's good to keep inflation in mind.
Fool's School
Beware of Value Traps
The classic mantra of investing is "buy low, sell high." Value investors, including great investors such as Warren Buffett, heed that, looking for undervalued stocks in which to invest. You'd do well to follow this strategy yourself, but beware of value traps.
A value trap is a stock that has fallen in price and appears to be undervalued -- but it's not. Here are some warning signs:
-- Debt issues: If a company has taken on too much debt -- perhaps in order to buy another company or just to keep operating -- that's a red flag. It will have repayment obligations that can hamstring it, and if it's not generating enough cash to pay down its debt, it can spiral into deep trouble.
-- Competitive issues: If the company is losing ground to competitors, which is reflected by a shrinking market share, it may be hard for it to maintain its value. Rivals may be offering higher quality or better prices.
-- Cyclical issues: Many companies are in cyclical industries whose fortunes ebb and flow with the economic environment. During a recession, for example, fewer people will spend money on cars, refrigerators or travel, and companies in those businesses may temporarily slump. But if a cyclical company is slumping during an economic boom, that's worrisome.
-- Management issues: If management doesn't seem to have a good strategy in place, or isn't executing its strategy well, that doesn't bode well for long-term success. If there has been a big change in leadership, that can be a wait-and-see situation, too.
-- Dividend issues: If the company is paying a generous dividend but isn't generating enough income to cover that obligation, or to increase its payout over time, that's a concern.
If you spot a possible value trap, dig deeper into it. Or just steer clear of it and instead focus on solid, easy-to-understand businesses, ones with strong track records and that seem well positioned for growth.
My Dumbest Investment
A Big Drop
My dumbest investment has been in Sierra Wireless, which has lost about three-quarters of its value over the last five years. -- J.B., online
The Fool responds: Sierra Wireless is involved in the "Internet of Things" (IoT) realm, which specializes in technology that facilitates communication with (and between) objects. (For example, your home security system might tell your heater that you've left the house so it can turn the heat down; soil sensors might alert farmers about irrigation needs.)
Sierra Wireless is facing sluggish IoT chip sales, falling chip prices and unfavorable macroeconomic conditions; these headwinds have slowed its growth and sent many investors running for the exit. Its future isn't certain at this point, but bulls are hopeful that it will turn itself around, with a greater focus on software; recurring revenue from service contracts; and the bundling of hardware, connectivity services and cloud-based management.
It wasn't necessarily dumb to have invested in Sierra Wireless; not every investment will make you money. You just have to think about what the future holds for the company. If you expect recovery followed by growth, hang in there. But if you've lost faith, sell and move those remaining dollars into a stock in which you have much more confidence. Always have your money invested in your most promising ideas. (The Motley Fool has recommended and owns shares of Sierra Wireless.)
Foolish Trivia
Name That Company
I came to life in 2006, offering an innovative way to house-hunt, and within three days had attracted more than 1 million visitors. I went public in 2011, with my shares soaring almost 79% on that first day. I bought my rival, Trulia, in 2015. Based in Seattle, I'm now home to a group of companies, including apartment marketplaces and an online mortgage company. In my last reported quarter, I bought 2,291 homes and sold 1,211. I had 2.1 billion visits, from nearly 200 million unique monthly visitors. My market value was recently near $8 billion. Who am I?
Last Week's Trivia Answer
I was conceived in 1998 as a money transferring platform, and was given the name Confinity. In 2000, I merged with Elon Musk's X.com online banking company, and I got a friendlier moniker in 2001. eBay bought me in 2002 for $1.5 billion. It spun me off in 2015, and my market value was recently over $120 billion. (eBay's value was recently about $28.5 billion.) Almost 10 billion payments were completed through me in fiscal 2018 -- 27% more than in 2017 -- and almost 300 million consumers and merchants use me. Venmo is my subsidiary. Who am I? (Answer: PayPal)
The Motley Fool Take
Profits Are Brewing
Dunkin' Donuts parent Dunkin' Brands (Nasdaq: DNKN) is reaping rewards from its On-the-Go Mobile platform and the introduction of new offerings such as premium espresso drinks and breakfast sandwiches. For example, the second and third quarters of this year saw 30% and 40% year-over-year growth, respectively, in espresso sales -- infringing on Starbucks' turf.
Dunkin' opened dozens of new locations during its last quarter and now sports more than 13,000 Dunkin' Donuts and 8,000 Baskin-Robbins locations. It's remodeling hundreds of stores annually -- upgrading their appearance and increasing the output of high-profit-margin items such as cold-brew drinks.
Dunkin' is midway through a three-year strategic plan announced back in February 2018. Its "Blueprint for Growth" involves a drive to steadily increase both revenue growth and operating income. It plans to expand the Dunkin' reach via 1,000 additional locations by late 2020, aiming for an eventual total of 18,000 U.S. locations.
To all this, add a dividend that recently yielded 2%, and Dunkin' Brands is a promising proposition for long-term investors. (The Motley Fool has recommended both Dunkin' Brands and Starbucks; it owns shares of Starbucks.)