Nvidia Replacing Intel in the Dow: A Shift in Blue Chip Definitions

The Dow Jones Industrial Average (^DJI 0.59%) is undergoing another significant change in 2024, with Nvidia (NVDA -0.84%) taking the place of Intel. Earlier this year, Amazon (AMZN -0.89%) replaced Walgreens Boots Alliance, and now Sherwin-Williams will replace the chemical giant Dow.

This evolving landscape of the 128-year-old index suggests that current changes reflect broader market trends, calling for a potential reevaluation of what it truly means to be a blue chip stock.

The Shift from Yield to Growth

In poker, the term "blue chip" refers to the highest denomination of chips. While there is no official definition for a blue chip stock, the traditional view held that all 30 companies within the Dow qualified, especially those with longstanding histories of increasing dividends, like the Dividend Kings—companies that have raised their dividends for at least 50 consecutive years.

Most, but not all, Dow components pay dividends. When Salesforce replaced ExxonMobil in the index in August 2020, it became the third member not to pay a dividend, alongside Boeing and Walt Disney. While Disney has since resumed its dividend at a lower amount, Salesforce also started paying a small dividend earlier this year. Currently, Amazon does not offer dividends, and while Nvidia does, it's only a nominal amount of $0.01 per share each quarter. In contrast, Sherwin-Williams has a yield of just 0.8%, while its predecessor, Dow, had one of the highest yields in the index at 5.7% as of Friday's prices.

After these adjustments, only 16 components will yield 2% or more, while eight will yield 1% or less. Historically, the Dow was known for dividend-paying companies, but this focus appears to be shifting toward emphasizing industry leadership.

Understanding Dividends and Capital Allocation

To grasp why dividends are integral to our perception of blue chip stocks, it’s essential to understand their purpose. A dividend allows a company to distribute earnings directly to its shareholders. Consistent dividend payments indicate a solid business, while increasing dividends year over year reflect thriving earnings, enabling higher distributions.

Nevertheless, dividends are just one form of capital allocation. Companies might pay down debts, retain cash, repurchase shares, pursue mergers and acquisitions, or invest back into their businesses for growth.

Many traditional blue-chip Dow companies face limited growth opportunities. For example, Coca-Cola shareholders would not favor risky investments in new beverage development, nor would Procter & Gamble wish to gamble on innovative paper towel designs. Similarly, JPMorgan Chase would prefer to grow steadily rather than take on excessive risk. Hence, these companies often reward shareholders through dividends, independent of market conditions.

In contrast, today's top companies often lean more toward growth than dividends. While Apple and Microsoft do pay dividends, they are minimal, at less than 1%. In addition, Alphabet and Meta Platforms began offering dividends earlier this year, yet their yields remain under 0.5%. However, a common practice among these major firms is stock buybacks, which reduce the share count and enhance earnings per share.

Opting for stock buybacks over dividends demonstrates management's belief that their stock represents a good value and can yield a better return. Companies like Apple, Microsoft, Alphabet, and Meta have significantly outperformed the broader market with this strategy.

Even Berkshire Hathaway, led by Warren Buffett, does not disburse dividends, as Buffett believes capital gains can provide greater returns than dividends. Despite lacking dividends, many regard Berkshire Hathaway as a blue chip stock. The same applies to Meta and Alphabet, which have only recently offered dividends, but what of companies that lack substantial dividends or repurchase programs?

Recent additions to the Dow, such as Amazon and Nvidia, have diluted their shareholders through stock-based compensation. Particularly notable is Amazon, known for reinvesting aggressively in various sectors. Over the last decade, Amazon's stock count rose by 13.1%, with the stock price soaring over 13-fold, making a strong case for its capital allocation approach.

Rethinking Blue Chip Stocks

The evolution of the Dow Jones Industrial Average prompts a reconsideration of the definition of a "blue chip" stock. Perhaps blue chip status should focus more on industry leadership and effective capital allocation rather than strictly on dividend payments.

A company should be deemed a blue chip if it leads its industry, generates ample excess capital, and utilizes that capital in ways that enhance shareholder value, whether through dividends, stock buybacks, or reinvestment in growth opportunities.

This broadening of the definition acknowledges that companies like Nvidia and Amazon may adopt aggressive strategies, but they must demonstrate that their capital investments result in tangible benefits for shareholders.

stocks, dividends, bluechip