In Love With The Dow

Strong's honchos say the S&P is too tech-heavy

Chuck Carlson of the two-year-old Strong Dow 30 Value Fund will take the Dow Jones industrial average over the Standard & Poor's 500-stock index any day. He observes that the S&P overweights megatechs, such as Microsoft, and underweights industrials, such as General Motors. Although the Dow recently added more tech to its average, Carlson thinks it's still more representative of the economy--and more likely to reflect any market shift into cyclicals. Carlson, editor of the DRIP Investor and No-Load Stock Insider newsletters, and co-manager Richard Moroney, editor of the Dow Theory Forecasts newsletter, have divided their portfolio so that half mirrors the Dow and half is actively managed. Last year, the no-load fund returned 27.1%, vs. 27.3% for the Dow. But it outpaced the S&P's 21% gain. Through Jan. 20, it has done a bit better than both the Dow and the S&P in weathering the whiplash market, dipping 1.1%, vs. 1.3% and 1.6%, respectively. Carlson spoke recently with Standard & Poor's FundAdvisor Associate Editor Jane Sandiford. (A longer version is available at

Q: How does the fund work?

A: You could call it an enhanced index fund. About 50% of the assets are in an equal number of shares in all 30 Dow stocks. The other 50% is actively managed. We like GM and overweight it. We don't like Coca-Cola, and we don't own any of it on the actively managed side.

Q: Why did you underperform the Dow in 1999?

A: One thing that hurt us was the Union Carbide [merger] with Dow Chemical. We had underweighted Union Carbide because it really was not a good value stock. Dow Chemical came along and proved us liars.

Q: Why do you prefer the Dow to the S&P?

A: The Dow is more representative of the economy. That view goes against conventional wisdom, which says the S&P is a better reflection because it's a broader index. [But] the top 30 stocks of the S&P 500 are large and, in many cases, technology-oriented. What I like about the Dow is that, with the recent addition of Microsoft, Intel, SBC, and Home Depot, it has greater New Economy representation, yet you still have old economy representation. One reason the Dow did better than the S&P last year was the strength we saw in some of the industrial cyclicals. For example, Alcoa was up 122% last year, and it's 3% to 4% of the Dow.

Q: When the the Dow bulked up its technology component last year, what did you do?

A: We pretty aggressively overweighted Intel and SBC.

Q: How do you pick the stocks to overweight?

A: We start out with a value screen that looks at traditional measures like price to earnings, price to sales, price to cash flow. Then we look for a catalyst for that value to be realized. A reason we like GM is we think the auto industry is going to hold up better in 2000 than others think. A kicker to GM is its holdings in GM Hughes [the huge satellite business that just agreed to sell its manufacturing operations to Boeing]. If you washed GM Hughes out of GM's price, the auto business is selling for less than four times earnings. We think GM is going to unlock some of the value this year with the GM Hughes business. Conversely, we try not to miss out on companies that are clearly not value stocks but that have strong price-earnings momentum. GE is a classic example. It's no bargain, yet it's a stock with sustainable, predictable earnings. So we try not to aggressively underweight stocks like GE, Home Depot, and Wal-Mart Stores.

Q: What other names are you underweighting?

A: Three stocks we don't own in the active portfolio are Coca-Cola, Procter & Gamble, and McDonald's. Coca-Cola hasn't demonstrated that it can rekindle earnings growth. And McDonald's and P&G look very pricey to us.