“My response time to the next glaringly attractive idea will be slashed to well under 50 years.”
- Warren Buffett, 1989 Letter to Berkshire Hathaway Shareholders
Imagine if you met someone who didn't know who LeBron James was. Or Taylor Swift, Jay Z, Tom Brady, Beyoncé, Katy Perry, Michael Jordan, Wayne Gretzky, Lady Gaga, Tiger Woods, Drake, or your superstar of choice. You'd probably say or think, “Are you from Mars? Have you been living under a rock?” Well, to be financially literate, you should know many of the key firms and businesspeople in the world economy today. They're the people and firms that help shape the world we live in. That's what this chapter and the next one are all about. In this chapter, we'll focus on the stocks of many of the leading firms in the world. In the next chapter, we'll focus on some of the leading businesspeople. So let's get started!
When thinking about some of the most important companies in the world, we think a good place to start is by checking out blue-chip firms. And when thinking about blue-chip firms, the first group that comes to mind for most financial professionals in the Dow Jones Industrial Average, or the Dow. The Dow is the oldest diversified stock market index in the US, if not the world.
We previously defined a stock market index as a basket or portfolio of stocks. There is often some sort of theme to the index. Dow Jones & Company, now owned by News Corp, is the publisher of The Wall Street Journal, the most widely read business periodical in the US, if not the world. Anyway, there was a person, Charles Dow, who co-founded this now internationally famous newspaper back in 1889.
People following or investing in the stock market typically have a couple of important questions. First, they may ask, “How did the stock market do today?” The time period—today, this week, month, year—can be any horizon, but to answer this question, you need a stock market index. Answering this question is one of the main reasons why Charles Dow created the Dow for his newspaper back in 1896.
A second question—not fully answered by the Dow or any market index—is, “How is my investment portfolio doing?” To answer this question rigorously, you should compute the performance of your portfolio and compare it to the performance of the market, assuming the two had similar risk. Here, we're talking about relative performance, like with a grading curve on an exam. If your teacher gave you a really tough exam and the average was 70, you might be pleased if you scored an 80. In contrast, if the average was 90 and you scored an 80, you might be disappointed. If you don't care about your performance relative to others, then good for you! Buffett would say you are following your Inner Scorecard (Tip 8), following your own belief system without paying attention to the thoughts of others.
Let's drill down on the concept of performance a bit, in the context of stocks. If your portfolio is up 15% and the market is up 10%, that'd be fantastic. The difference between your portfolio's returns and those of the market is called alpha, assuming the portfolios had similar risk. If they didn't have similar risk, it's not an “apples to apples” comparison, and we'd have to make some adjustments, which we aren't going to get into here. If your portfolio is up 15% and the market is up 20% then perhaps you didn't do so well, your alpha is –5% in this case.
The calculation is pretty simple on the surface. You can think about adding up the prices of the 30 stocks in the Dow and then just dividing by 30. Piece of cake! It's almost that simple. Originally, there were only 12 stocks in the index, but the number increased to the familiar 30 in 1928. So the increase from 12 to 30 stocks is one adjustment that needed to be made. There are two other adjustments that get us to the present-day Dow levels.
Occasionally, stocks get removed from the index. Why? Rarely, another firm will buy them. Less rarely, but still uncommon, the folks at Dow Jones who run the index kick some firms out and replace them with new firms. They usually have shrunk in size or are no longer considered blue chip. There have been less than 60 changes in the Dow since it began back in 1896. That's not a ton of changes (less than one every two years), but it still required an adjustment. For example, there were once stocks in the Dow that went by the name of American Sugar Company, U.S. Leather Company, and Laclede Gas Company. The most recent changes occurred on August 31, 2020, when Amgen replaced Pfizer, Honeywell replaced Raytheon Technologies, and salesforce.com replaced Exxon Mobil.
Buffett has written about once-great companies that have faltered. In his 2014 Letter to Berkshire Shareholders, he wrote,
My successor will need one other particular strength: the ability to fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency. When these corporate cancers metastasize, even the strongest of companies can falter. The examples available to prove the point are legion, but to maintain friendships I will exhume only cases from the distant past. In their glory days, General Motors, IBM, Sears Roebuck and U.S. Steel sat atop huge industries. Their strengths seemed unassailable. But the destructive behavior I deplored above eventually led each of them to fall to depths that their CEOs and directors had not long before thought impossible. Their one-time financial strength and their historical earning power proved no defense.
Let's summarize the quote about companies gradually losing their power with a Tip.
The third reason for an adjustment to how the Dow is computed is something called a stock split. We'll define it in more detail in the next section, but for now you can think of it as changing a $10 bill for two $5 bills. It's more or less an accounting trick that has no real economic value. We know you're dying of suspense, wondering why firms might do this. The answer will be revealed in the next section. The key thing for now is the price of stock gets lowered and the number of shares outstanding increase, even though there has been no real effect on the company.
It's pretty easy to see why an adjustment is needed by looking at some basic numbers. Today, the Dow is trading at levels greater than 27,000. And, other than Berkshire Hathaway—which is not currently a member of the Dow—there is no company in the US with a stock price greater than $27,000. So how can adding up the prices of the 30 stocks in the Dow and dividing by 30 result in a number like 27,000? Because of the 3 reasons we mentioned, but mostly because of stock splits.
The Dow is a price-weighted index. This means stocks with a high price, such as Visa in recent years, count for a greater weight in the index than a firm with a lower price, such as Coca-Cola. To give a school analogy, a test usually counts for more than a quiz when determining your overall grade for a class. In this case, the high-priced stock (Visa) is like your test grade, while the low-priced stock (Coca-Cola) is like your quiz grade.
A more common type of index is a value-weighted or market cap–weighted index. The S&P 500 is probably the most common value-weighted index. Here the weight of the stock in the index calculation isn't determined by its price per share but rather the price per share times the number of shares outstanding, the definition of market cap. For example, Microsoft was recently valued at more than $1.6 trillion. It's weight in a value-weighted index, such as the S&P 500, would count more than 1000 times than a firm with a market cap of only $1.6 billion. Sticking to our grade analogy, Microsoft would be the equivalent of a huge final exam, and the $1.6 billion stock would be the equivalent of a trivial homework assignment.
One last term for this section. A point means a dollar change, or a change in whatever unit of currency you are using. If a stock went up 2 points, in the US it means 2 dollars. In Germany, it would mean 2 euros. In Great Britain, 2 pounds. Of course, it could go down points as well. The term also applies to a market index such as the Dow or S&P 500 as well.
A move of, let's say, 5 points may or may not be meaningful. If Berkshire (Class A) stock goes down 5 points, it’s barely a rounding error. However, if it's a stock such as Coca-Cola, currently trading in the $50 a share range, it would be a big move. So one point to remember is that it's the percentage change in the price of a stock, portfolio, or index that counts since it most closely relates to how your wealth is changing.
As we mentioned a minute ago, a stock split is an accounting trick or gimmick that essentially changes a $10 bill into two $5 bills. Obviously, the amount of money you have, $10 in this case, is unchanged. That's why it's simply accounting sleight of hand. Let's do a similar calculation with a stock. Suppose you own 100 shares of stock that is worth $50 a share. Multiplying 100 shares times $50 equals a value of $5,000.
With a stock split, the company specifies the ratio of the split, with the most common being 2 for 1. So, in our example, after a 2-for-1 split, you would have 200 shares of stock (2 times 100), but the stock price would be cut in half, ($50 divided by 2), from $50 a share to $25 a share. The dollar value of your position, $25 a share times 200 shares, is still $5,000.
Why go through all of this trouble if the value of your shares is still the same? Well, it's mainly due to investor psychology. If you walk up to the typical investor on the street and ask them, “Would you rather have 100 shares of stock or 200 shares?” nearly everyone will say 200 shares and not bother to ask about the effect on the share price. On the surface, you sound richer owning more shares, but we know if the price of the stock is cut in half after a 2-for-1 split, you really aren't richer. Some naïve people also think that since the price of the stock is now $25 and yesterday it was $50, it's cheaper and a better deal. That line of thinking is flawed since is the intrinsic value of the firm (i.e., the present value of its future cash flows) or a multiple of current earnings that counts, not the actual price.
In fact, we can make a case that Berkshire Hathaway (class A shares) are cheap at more than $300,000 a share, while many firms trading at $10 a share or less are expensive. How? Berkshire may be trading at a low price compared to the present value of its future cash flows or a multiple of its current earnings, while the $10 stock may be selling at a high valuation, or have little to no prospects for earnings.
Besides preying on investor psychology, why do many firms split their stock? A phrase you see used in press releases by firms splitting their stock is “increased market liquidity.” We've discussed this concept several times. As a refresher, a liquid asset is one that may be sold quickly and at fair market value. So the company may believe that by splitting its stock, the lower share price will make it accessible to more investors and that may result in more trading and lower transaction costs. This may have been true many years ago when it was required that investors had to buy a round lot of shares. A round lot means 100 shares or more. Transactions less than 100 shares were often sent to the odd lot desk, where trading of orders less than 100 shares took place. Today, it is not necessary to purchase a round lot in order to have lower transaction costs. Most brokerage firms will charge you a flat fee, say $10, for any buy or sell transaction up to 1,000 shares. In fact, many brokerage firms, such as Schwab, Fidelity, and Robinhood, have gone to a $0 commission structure, making the distinction even of less relevance today. Furthermore, some brokerage firms have the capability of allowing their clients to own a fraction of one share.
We don't want to go off on too much of a tangent, but there is also something called a reverse split, where the number of shares you own are reduced but the price per share goes up. For example, if you owned 1000 shares of a stock trading at $1 a share, after a 1-for-10 reverse split, you would own 100 shares of a stock now trading at $10 a share. The total value, price times number of shares, is still $1,000. Why would firms do this? Most exchanges require the stock to be at least $1 a share to remain listed on the exchange. Although this is still an accounting gimmick, stocks usually go down after a reverse split since it provides a signal that the company is in somewhat dire straits. Companies that no longer trade on the exchange are the equivalent of bad kids being kicked out of school, not a good idea under almost all circumstances.
Buffett has weighed in on stock splits, and as you might guess given Berkshire's stock price, he is not a fan of them. In Berkshire's 1983 Shareholder Letter, he wrote, “Were we to split the stock or take other actions focusing on stock price rather than business value, we would attract an entering class of buyers inferior to the exiting class of sellers…People who buy for non-value reasons are likely to sell for non-value reasons. Their presence in the picture will accentuate erratic price swings unrelated to underlying business developments.” Since a stock split is basically an accounting trick, there is no fundamental value to it. Let's summarize his quote with a Tip.
As Berkshire's shares rose dramatically in price without splitting, some people couldn't afford even a single share. Several stock promoters sprang up that would sell investors a fraction of a Berkshire share, while earning the promoter a fat sales fee or commission. Buffett wasn't a fan of this structure so he decided to create Class B shares of Berkshire Hathaway to make them more accessible to smaller investors. You may be thinking, “What are Class B shares and why would a firm have them?” We're glad you asked.
Most companies have only one share class. One share of a stock for these firm entitles its holder to have one vote on company matters sent for voting to their shareholders. Shareholders of a firm often vote on matters related to who should be appointed to the board of directors that runs a firm, and they select the accounting firm that audits a firm's financial statements, as well as many other items. A small percentage of firms have two share classes, with the main difference between the two share classes being the right to vote on company matters. Firms such as Alphabet/Google and Under Armour have two share classes. Having two share classes provides the founders, or their heirs, a way to maintain control of a firm even if their ownership share falls below a 50 percent majority.
In Buffett's case, he didn't create Class B shares of Berkshire to maintain control of the firm. He and his close friends own the majority of Berkshire shares. Rather, he did it to foil the plans of the promoters who were earning large fees at the expense of the small investor. Thus, in 1996, he created Class B shares of Berkshire Hathaway, which currently sell for 1/1,500 the price of Class A shares. Other than the price and voting rights, everything else is the same for Class B shareholders. They are still entitled to share in the same businesses that Class A owns and the related profits. If Berkshire paid dividends, Class A and Class B would get the same share of dividends on a percentage basis.
One advantage of owning at least a single Class B share of Berkshire is that you will get invited to the annual Berkshire Hathaway shareholder meeting, known in the financial press as “Woodstock for capitalists.” Tens of thousands of people attend in person each year, and millions more view the proceedings online, streamed by Yahoo! The meeting was moved to an all-virtual meeting for 2020 in the wake of the COVID-19 pandemic. Woodstock may have occurred well before your time, but it was an epic music and art festival back in the summer of 1969 that feature3 a bunch of future “hall of fame”-type bands including Jimi Hendrix, The Who, Santana, Jefferson Airplane (later Starship), Crosby, Stills, Nash & Young, Sly and the Family Stone, and the Grateful Dead. The other advantage to owning shares in Berkshire Hathaway, of course, is owning a piece of a fantastic business, managed by Buffett and his colleagues.
And now on to the main event, a brief discussion of the current 30 stocks in the Dow, followed by another brief discussion of some other global blue-chip stocks. The past and current selectors of stocks in the Dow want to get a mix of companies, just like there's a diverse range of companies in the economy. We'll organize the companies by sector. The stock market is made up of individual stocks, which roll up or combine into an industry. The industries roll up into sectors. The sectors then roll up to the aggregate or overall market. For example, technology is a market sector that is comprised of industries including computer software, computer hardware, and computer services. In this section, we'll cover the sectors of the Dow, but you should be aware that the S&P 500 has some slightly different categorizations that we won't cover here.
The sector materials refers to stocks that are involved in commodities, such as oil, natural gas, crops, and chemicals.
Chevron, formerly Chevron Texaco, is one the largest energy firms in the world. There are three main parts to the oil business. The upstream segment finds and drills for oil and gas. The midstream segment refines or cleans and transports the (dirty) crude oil pulled from the ground or sea. The midstream segment mainly consists of oil refineries and pipelines. The downstream segment includes selling oil and gas products at the retail or consumer level. For example, Costco sells gasoline at some of its stores and is part of the downstream segment but doesn't have any businesses in the upstream or midstream segments. A firm that is active in all three segments, such as Chevron, is called fully integrated. It might surprise you to learn that that many of the products that we use are (at least partially) made from oil, including plastics, candles, and ChapStick lip balm.
Dow Chemical is, as its name suggests, a chemical company and it has no relation to Dow Jones. Dow Chemical merged with DuPont, another large chemical firm, back in 2015. DuPont was the firm that was first part of the Dow index, not Dow Chemical. But guess what? Dow and DuPont split into three companies in 2019, with the third component now known as Corteva. We know, kind of crazy, but it's a story we'll leave for another day. Chemicals go into tons of products, including cleaning agents and pesticides, and are often derived from oil.
As the name indicates, firms in the consumer and businesses services sector sell goods or services to consumers and businesses. You probably have the most interaction with consumer firms in this sector since they include restaurants, clothing retailers, and department stores.
Home Depot is the largest home improvement retailer in the world. Pretty much anything you need for your home you can find at Home Depot. They have more than 2,200 stores worldwide, mostly in the US, Mexico, and Canada. They also do a ton of business with home building–related firms and contractors, who install or repair items in a home. Their primary competitor is Lowe's, although they also compete to a certain extent with Wal-Mart and Amazon.com. One of the few products where Amazon.com may not be able to compete effectively is cement. The shipping costs are often more than the price of the product itself!
McDonald's is one of the pioneers of the fast food industry and one of the largest restaurant chains in the world. McDonald's was one of the first restaurants to apply assembly line techniques to selling food. Fast food is known for being inexpensive and served quickly but often is not considered the most nutritious. There is a relatively new segment of the fast food industry known as fast casual. Fast casual firms serve food quickly, its customers are often not expected to leave a tip, and the food tends to be more nutritious than what's served at McDonalds, Burger King, Hardee's, and Wendy's. Chipotle and Panera Bread are perhaps the two best known fast casual firms that you've probably come across.
Walmart is the largest retailer in the world, measured by annual sales. It might surprise you to learn that they are the biggest seller of groceries and long-lasting consumer products, known in industry terms as dry goods. They are even one of the biggest sellers of diamonds in the US. Diamonds? Say what? For some people, especially in rural areas, Walmart is pretty much the only game in town. Walmart's main competitors are Target, Costco, and Amazon.com.
One of Buffett's biggest regrets is not buying stock in Walmart when it was a much younger growth firm. It was a business he understood and operated on a bigger scale than some of Berkshire's successful retail subsidiaries, Nebraska Furniture Mart (NFM) and Borsheims, a jewelry store. In his 1989 Letter to Shareholders, he wrote, “NFM and Borsheims follow precisely the same formula for success: (1) unparalleled depth and breadth of merchandise at one location; (2) the lowest operating costs in the business; (3) the shrewdest of buying, made possible in part by the huge volumes purchased; (4) gross margins, and therefore prices, far below competitors’; and (5) friendly personalized service with family members on hand at all times.” There are some important lessons in this quote for stockholders and business owners alike, so we'll include it as one of our most verbose Tips.
There is some overlap with the consumer goods sector and the consumer and business services sector we discussed above. The main difference hinges on the words “services” and “goods.” A consumer services firm, such as Walmart, sells the products of many other firms. In contrast, a consumer goods firm, such as Nike, may operate some of its own stores, but it sells the bulk of its products through other companies, such as Foot Locker, Dick's Sporting Goods, and DSW.
Apple is one of the most profitable, valuable firms in the world and perhaps best known for its iPhone product. Apple started out as one of the pioneers of the personal computer business. They also created a number of other wildly popular products such as the iPod, iPad, and Apple Watch. Yeah, we know most people view Apple as mostly a technology firm, but research firms put it in the consumer goods sector since it sells most of its products, especially iPhones, to consumers. Apple usually ranks among the most valuable stocks in the world, currently worth more than $2 trillion!
Apple is currently Berkshire's biggest stock position even though Buffett historically has shied away from tech stocks since he claims he doesn't understand the industry. But he likes Apple's customer loyalty and the firm's ability to raise prices and have customers buy new versions of its products due to this intense loyalty. In an interview on CNBC discussing Apple and the iPhone, he said, “You can't move people by price in the smartphone market remotely like you can move them in appliances or all kinds of things. People want the product. They don't want the cheapest product…It's a very, very, very valuable product to people that build their lives around it. And that's true of 8-year-olds and 80-year-olds.” We think there is Tip in there.
Virtually everyone knows Coke. It's one of the most recognized brands in the whole world. Coca-Cola is the largest non-alcoholic beverage company in the world, with operations in more than 200 countries. Their brands include Coke, Diet Coke, Sprite, Tab, Fresca, Dasani, Powerade, and Minute Made juices. Their main competitor is PepsiCo, which somewhat surprisingly makes most of its profits from selling snack foods such as Lays Potato Chips, Tostitos Tortilla Chip, and Doritos. One last note on Pepsi: they are the maker of Gatorade. Smaller competitors to both Coke and Pepsi include Cadbury Schweppes and Dr Pepper Snapple.
Coke has been one of Buffett's best investments. He's made more than ten billion dollars from it since his first purchase back in 1988. But he tells a fascinating story in his 1989 Letter to Shareholders that he should have bought the stock much sooner. He writes:
I believe I had my first Coca-Cola in either 1935 or 1936. Of a certainty, it was in 1936 that I started buying Cokes at the rate of six for 25 cents from Buffett & Son, the family grocery store, to sell around the neighborhood for 5 cents each. In this excursion into high-margin retailing, I duly observed the extraordinary consumer attractiveness and commercial possibilities of the product.
I continued to note these qualities for the next 52 years as Coke blanketed the world. During this period, however, I carefully avoided buying even a single share, instead allocating major portions of my net worth to street railway companies, windmill manufacturers, anthracite producers, textile businesses, trading-stamp issuers, and the like. (If you think I'm making this up, I can supply the names.) Only in the summer of 1988 did my brain finally establish contact with my eyes.
In fact, if I had been thinking straight I would have persuaded my grandfather to sell the grocery store back in 1936 and put all of the proceeds into Coca-Cola stock. I've learned my lesson: My response time to the next glaringly attractive idea will be slashed to well under 50 years.
There's an important lesson in this humorous story that we'll include as our next Tip.
Nike is the largest athletic shoe (i.e., sneaker) company in the world. Their Air Jordan and Nike LeBron brands are their most popular sneakers. Converse is also owned by Nike, after they purchased the firm in 2003. Nike also sells all sorts of athletic apparel and equipment including T-shirts, shorts, cleats, and jerseys. They are known for their catchy marketing slogans, such as “Just Do It,” and their celebrity endorsers including Michael Jordan, LeBron James, Tiger Woods, Zion Williamson, Maria Sharapova, and Christian Ronaldo. Their main competitors include Adidas, Puma, and Under Armour.
Procter and Gamble (P&G) is one largest consumer product firms in the world. They sell a bunch of the stuff you'll find in the supermarket. Some of their main brands include Ivory Soap, Covergirl, Head and Shoulders, Cheer, Tide, Oxy, and Tropicana. Their main competitor is Unilever, a Netherlands-headquartered firm with global operations.
Walgreens Boots Alliance is mainly known for its US drug store chains, Walgreens and Duane Reade. If you haven't been in one of their stores, they may be viewed as retail stores that sell healthcare products, cosmetics, and convenience items. The Boots Alliance part of the name relates to international pharmacies Walgreens acquired in a 2014 merger. The combined company is huge—they operate about 15,000 stores worldwide.
Disney is a large media and entertainment firm. You probably know about their theme parks, movies, and Disney+ video on demand service. Did you also know they own ESPN and ABC TV? In recent years, they bought some other movie companies: Pixar (maker of computer animated films), Marvel (maker of comic books and related movies), Lucasfilm (creator of the Star Wars and Indiana Jones franchises), and the film and TV business of Fox. They also own a majority stake in Hulu, another subscription-based video service.
Financial stocks are somewhat self-explanatory. They include banks, credit card companies, insurance firms, investment management firms, and investment banking firms.
We previously mentioned American Express in our discussion on credit cards and charge cards, as well as with our recounting the tale of Buffett's purchase of the stock when it was suffering from the effects of the salad oil scandal. Amex was originally in the business of express mail delivery, money orders, and traveler's checks. American Express is one of the pioneers of the rewards programs in credit cards, where the card issuer provides you with nice perks such as free airline tickets and cash back on purchases. They also provide credit cards for many businesses and their employees who pay for business-related expenses on the company's dime.
We previously mentioned Goldman Sachs as an example of Buffett putting his maxim to work—“Be fearful when others are greedy. Be greedy when others are fearful”—during the Great Recession. Goldman Sachs is one of the largest and most prestigious financial firms in the world. For many who work or want to work on Wall Street, it's their dream to work at Goldman Sachs. It is sort of like the New England Patriots, New York Yankees, or Golden State Warriors of the financial world. That is, they consistently win. Goldman has large investment banking, investment management, and securities trading units, as well as a growing online retail bank.
JPMorgan Chase is one of the largest financial firms in the world. It was founded in 1871 by J.P. Morgan, a person we'll discuss in the next chapter. They provide a mix of traditional banking and investment banking services to both individuals and companies around the world. Chase is their retail unit, which accepts deposits, provides loans, and issues credit cards, among other activities. They also have a large investment banking division and a wealth management unit, primarily geared towards individuals with $10 million or more in assets. We hope you'll get there someday by following the lessons in this book!
Travelers is one of the largest insurance firms in the US. Perhaps you've seen their famous red umbrella logo. There are all sorts of insurance products. Car insurance is likely the first insurance product that most people purchase. Other types of insurance products you'll probably use in your lifetime include homeowner's insurance (in case something happens to your home) and life insurance (providing money for your heirs after passing away, hopefully a long, long time from now).
We discussed credit cards in Chapter 3. Visa is the largest credit card company in the world. You may not know how they primarily make money. Let's say you buy a shirt at Macy's for $20 and pay for it with your Visa credit card. Macy's doesn't net $20 from the sale. It makes about 97 or 98 percent of it ($19.40–$19.40). You might say, Visa gets 2 to 3 percent of billions and billions of dollars of sales for doing practically nothing? Well, they do a lot behind the scenes including reimbursing customers whose cards have been lost or stolen and operating some of the “plumbing” of the financial payments system.
Health care stocks include firms that provide health insurance, develop prescription drugs, and sell and distribute prescription drugs, as well as firms that sell all sorts of medical devices ranging from insulin pumps to artificial hearts.
Amgen is one of the largest biotechnology firms in the world. As the name indicates, biotechnology firms use technology to discover new drugs, in contrast to the traditional test tube and trial-and-error process of drug discovery. Since there are several pharmaceutical stocks in the Dow, we'll give you a really quick primer on the FDA approval process, for which there are three phases. Phase 1 aims to make sure the drug is relatively safe. Of course, virtually all drugs have side effects, but the main goal of phase 1 is to make sure the side effects of the drug for most people aren't worse than the disease. The goal of phase 2 is to make sure the drug works for most people, formally known as testing the efficacy of the drug. Phase 3 tests the drug on a larger sample of people and also against a sugar pill, known as a placebo. If the trial is double-blind, neither the patient nor the doctor knows who is getting the real drug. The patients taking the real drug should have better results than those taking the sugar pill. It might surprise you, but less than 0.1 percent of drugs make it from the test tube to the market!
Johnson and Johnson (J&J) is one of the largest health care firms in the world. It has three main segments: A consumer segment, which sells products such as Band Aids and Tylenol; a pharmaceutical segment, which sells prescription drugs; and a medical device segment, which sells things such as artificial hips, knees, and heart stents, which are designed to keep blood vessels open.
Merck is another large health care firm that sells pharmaceutical products, mostly of the prescription drug variety. One factoid that you may not know: It often takes more than a decade to bring a drug from the lab testing phase to the market as a final US Food and Drug Administration (FDA)–approved product. This is one reason why patents often last up to 20 years. Otherwise, there would be little incentive to do all the costly research and development work.
UnitedHealth Group is the largest provider of health insurance in the US. Health insurance pays the doctors, hospitals, and pharmacists that may treat you. Many people get health care insurance as a benefit, a form of non-cash compensation, from their job. Seniors often get health care services through Medicare, a government health program for the elderly. There are also a number of other important government-sponsored health care plans. Health care generally isn't free. Even if you get health insurance from your employer as part of your benefit plan, it's usually not free. You often have to pay part of the bill, known as a co-pay. For many people, especially the elderly, health care is one their largest expenses.
Industrial goods stocks typically make some sort of equipment or provide products that are used as input into other products. For example, one of GE's biggest products is selling aircraft engines. To throw you for a loop, Rolls-Royce is also in the aircraft engine business. Rolls-Royce doesn't even make its namesake cars anymore. It sold the rights to BMW more than a decade ago. That's right, Rolls-Royces are produced by BMW!
Boeing is one of the largest makers of commercial aircraft, a fancy term for the jets most people fly on. Perhaps you've flown on a 737, 747, or their new Dreamliner jet. Their main competitor is the European firm Airbus. Boeing also has a large national defense business and was one of the main companies involved in producing the space shuttle.
Caterpillar is the world's largest maker of earthmoving equipment. That's the kind of things you see at many construction sites, such as cranes, diggers, bulldozers, and steamrollers. They are well known for the yellow and black colors that adorn their equipment. These days, much of the construction around the world is taking place outside of the US, especially in China and India. Most of their sales are outside the US making them a truly global firm.
Honeywell makes a variety of products, too numerous to mention in detail, but most consumers know them from the thermostats that regulate the temperature in their homes. The firm also is heavily involved in the aerospace, defense, surveillance, fire protection, and software industries. For example, the firm competes with Google Nest's range of wireless enabled devices, a segment known as “the Internet of things.” Honeywell returned to the Dow in 2020 after a roughly ten-year absence. Like Berkshire, Honeywell is considered a conglomerate, or a firm with businesses that span a range of unrelated industries.
3M was originally known as Minnesota Mining and Manufacturing company. They aren't in the mining business anymore and are known primarily as an industrial firm. You almost certainly know a couple of their products, Scotch Tape and Post-It Notes. Yep, that's MMM. During the COVID-19 pandemic, there was a shortage of their N95 masks. They have a bunch of other business lines besides tape or adhesives, including automotive, health care, security, electronics, and energy.
The technology sector covers several industries including computer hardware, software, and services. One thing to remember about the Dow is the companies included in the index all have a multi-decade history. So, despite the recent success of Facebook, it is not yet included in the index. Since the Dow is a price-weighted index, it's unlikely that super-high-priced stocks such as Berkshire (Class A), Alphabet, and Amazon.com will make it into the Dow, unless they split their stock. The founders of the latter two firms have expressed their admiration for Buffett and Berkshire, so we don't think their inclusion is likely anytime soon. And we know Buffett won't split Berkshire's stock, although we do think there is a chance that its Class B shares may make it a candidate for the Dow someday.
Intel is one of the largest computer chip makers in the world. Wall Street calls computer chip makers semiconductor firms. Intel is best known for their central processor unit (CPU) chips, which power most laptops and computers around the world. Intel also owns the antivirus software maker McAfee. Intel recently purchased another chip company called Mobileye, which makes the computer chips that may help power many driverless cars.
International Business Machines (IBM) is one of the largest makers of computers in the world. They focus on large computers, the kind that used to fill up whole rooms. Perhaps you saw the hit movie Hidden Figures. If so, you got a glimpse of what IBM's computers looked like several decades ago. IBM has been around more than 100 years, and computers were created in the 1940s and 1950s. What did they sell before then? The answer lies in IBMs full name. It sold business machines, including things such as cash registers. They also have a large information services (IT) business, running all or part of the computer departments for many firms around the world. When a company farms out something it historically does itself, such as IT services, it's called outsourcing. IBM also has a renewed focus on artificial intelligence (AI) software through their Watson product, which is similar to Siri, Alexa, and other voice-activated assistants. In an effort to increase their sluggish growth, IBM purchased Red Hat in 2019, a firm that focused on cloud-based open-source software, such as Linux.
Microsoft is the largest computer software company in the world. They are best known for their computer operating system, Windows, and MS Office, recently renamed Microsoft 365, a package of software productivity programs. It includes Microsoft Word, Excel, and PowerPoint. Microsoft also produces the X-box gaming unit, a competitor to Sony's PlayStation and Nintendo's Switch. A few years ago, Microsoft purchased Nokia's phone unit, but they haven't yet made much headway against Apple's iPhone and Samsung's Galaxy line of phones. They also own Skype, a software program that lets you make calls around the world for virtually nothing, and LinkedIn, a job-oriented website that we'll touch upon in Chapter 15 on careers. The resurgence of Microsoft's stock over the past several years has been due in large part to the success of their cloud computing unit, Intelligent Cloud.
The stock symbol of salesforce.com, CRM, provides a clue to the types of services that the firm provides. Specifically,CRM is the acronym for customer relationship management software. For example, if you call your cellphone provider, they probably have notes in your account about the last time you called, the type of phone you have, the features of your service plan, and so forth. salesforce.com is pioneer of keeping their software in the cloud, making it easily accessible via smartphone or laptop to users on the go. Their products are sold as part of a subscription model known as software as a service (SaaS). They also purchased the Tableau, a firm that is best known for its data visualization products, in 2019. And yes, the company refers to itself in all lowercase, but thanks for keeping us honest with your grammar vigilance. :-)
Telecommunications services refers to companies that help enable phone calls, the Internet, or the equipment used to power these industries.
Cisco is a shortened form of the city San Francisco, a city located near the company's headquarters in Silicon Valley, California. Cisco is best known for selling networking equipment, which provides the backbone of the Internet. We don't want to bore you too much with technical details, but one of the earliest types of products that Cisco sold is called an Internet router. When you visit a webpage, the router is the piece of equipment that helps send the webpage from the computer server of the host company (such as Yahoo.com) to your computer, tablet, cell phone, or other Internet-viewing device. In recent years, the company has become much more diversified, selling a range of hardware, software, and security-related products.
Verizon was once part of AT&T (a long story) and is the largest cell phone provider in the US. They also own a large cable TV network under the brand name FIOS. In recent years Verizon has expanded into the Internet business. They purchased America Online (AOL) several years ago and more recently purchased Yahoo!, one of the most widely visited websites in the world.
So those are the 30 blue-chip firms in the Dow and a brief mention of some of their competitors. But there are a lot more important companies out there. Let's briefly discuss some of the key firms in the US and also from the rest of the world.
Since the Dow is an old index that consists of blue-chip stocks, its selection committee tends to be conservative regarding any additions. They don't want to pick some shooting star or flash in the pan and then have the stock flame out. We also mentioned the performance distortion issues with including high-priced new stocks in the Dow, such as Berkshire (Class A).
Let's start with the so-called FANG stocks. FANG is the acronym for Facebook, Amazon.com, Netflix, and Google (now formally known as Alphabet).
Facebook is a leading social media firm with well over a billion active users each day. Social media is an electronic platform that enables people to share ideas, comments, pictures, videos, career interests, and much more. Facebook is a convenient way for keeping in touch with your friends and a whole lot more. Facebook also owns Instagram, a photo-sharing and social media company They also own WhatsApp, an app that allows you to text and make phone calls at virtually no cost. WhatsApp also has over a billion active users.
We've mentioned Amazon.com several times in this book. It is hard to describe how many ways this firm touches your life beyond shopping. One of their popular consumer products is Echo. On the surface it's a speaker, but it's really a virtual assistant. As AI expands its capabilities, you'll be able to use Echo for a lot more than playing music, checking the weather, or purchasing items. We can't wait to see how it unfolds. As with Microsoft, Amazon.com also generates much of its profitability from its cloud computing unit, Amazon Web Services. They also expanded into the grocery space in a meaningful way with their acquisition of Whole Foods in 2017.
Netflix is a great way to watch movies, TV shows, educational videos, and other items. They started out renting DVDs through the mail. Today, most of their business involves the online streaming of video content. They are likely the biggest user of Internet bandwidth (i.e., traffic) in the world. Netflix users often engage in a behavior known as binge watching. In the past, when a TV show aired, you had to watch one episode a week. With binge watching you can watch a whole season in one weekend. Increasingly, consumers are “cutting the cord” from their traditional cable provider and moving to a video streaming service, such as Netflix, to meet their entertainment needs. In case you are looking for a TV show to add to your binge-watching list, consider Breaking Bad, a Buffett favorite.
Everyone knows Google as the most popular search engine in the world. But they also own YouTube and are working on some other cool projects such as driverless cars. Google Maps is the most popular navigation app in the world. If you prefer Waze as your navigation app, they own that too. Since they are doing a lot more than search, the firm decided to rename itself Alphabet. Google is still the core, but like Amazon.com they continue to amaze us with what they have up their sleeve.
Tesla is another company that gets many of the financial headlines today, although it is technically not a member of the FANG stocks. It pioneered the development of the electric car. The cars are so impressive that Consumer Reports gave their Model S sedan its highest rating ever. You have to tip your hat to a company that has a car that is as fast as a Ferrari and handles like a Porsche, despite some of their challenges with consistently generating profitability. Wall Street clearly believes in their potential, since their market cap is larger than Ford, GM, Volkswagen, and Daimler (Mercedes) combined! They also merged with SolarCity, a leading provider of solar roofs. Its CEO, Elon Musk, has a vision of colonizing Mars with one of his other companies, SpaceX. Now that's thinking big! We'll get back to Elon Musk in the next chapter on “Who's Who in Business.”
China currently has the second-biggest economy in the world in terms of GDP, and they are poised to pass both the US and the European Union (EU) in our lifetimes. We'll briefly mention the “Big 3” of China's tech firms, Alibaba, Baidu, and Tencent. A fourth large tech firm, ByteDance, which owns TikTok, is privately held. It is currently caught in the crossfire of a skirmish between the US and China and may be sold, in part, to Oracle. Alibaba is like the eBay plus Amazon.com plus PayPal of China. They not only have a platform to sell products to consumers, but they also have a robust business-to-business (B2B) platform. What does B2B mean? Let's say you have a business that sells T-Shirts. Your business might need a firm to manufacture the T-Shirts in bulk. That's where Alibaba comes in. By searching their website, you may be able to find a firm that manufactures your T-Shirts cheaply. You could then focus on other aspects of your business, such as marketing and finding places that will stock your T-Shirts, a process known as distribution. Alibaba also has an electronic payments system, similar to what we discussed with PayPal in Chapter 3. It's called Alipay and is part of Alibaba's financial arm, called Ant Financial.
Baidu is similar to the Google or Alphabet of China. They are the leading search engine in China (Google is currently banned there, outside of Hong Kong). Not coincidentally, they also have a driverless car and other AI projects that may spur their next legs of growth. We also want to mention Tencent. No relation to 50 Cent, the musician. Facebook is currently banned in most of China, and Tencent has emerged to be the leading social media firm in the country. They are also the leading mobile gaming firm in the world (i.e., playing games on your phone, computer, or tablet) and dominate the Chinese instant messaging market. Perhaps the most valuable part of Tencent is their app WeChat, which also doubles as a payment system, like Alipay. We have no doubt that you'll be hearing a lot more about these three firms in the decades to come.
Energy is one of the most important industries in the economy. Most of us use energy for transportation (cars, trucks, airplanes, trains, etc.) and for heating our homes (natural gas, heating oil, and coal). Saudi Aramco, largely owned by the royal family that rules Saudi Arabia, owns virtually all of the oil fields in Saudi Arabia. It also has a large market share in the midstream and downstream segments that we discussed. The government sold a small piece of Saudi Aramco to investors in 2019 and plans to use the money to help develop new industries that may thrive when the oil eventually runs out. Shortly after its IPO the stock peaked at roughly $2 trillion, making it the most valuable stock in the world at the time. Today the market cap of the firm is closer to $1.75 trillion, a number that would even make Buffett envious.
Other major international energy firms include Gazprom (largely owned by the Russian Government), British Petroleum (BP), Royal Dutch Shell (a British-Dutch Firm), PetroChina (China), Petrobras (Brazil), Total S.A. (France), and Eni (Italy). We should also mention the American energy titan Exxon Mobil. We noted earlier in the chapter that it was kicked out of the Dow in 2020 and replaced with salesforce.com, primarily to increase the technology weight in the index after Apple completed its 4:1 stock split.
We mentioned earlier in this chapter that Unilever is a Netherlands-based consumer products firm that is most similar to America's Procter & Gamble. Some of Unilever's best-known brands include Breyer's, Ben & Jerry's, Dove (soap), Hellmann's (mayonnaise), Lipton (tea), Vaseline, and Q-Tips. You probably have some awareness of the major global auto firms. Ford, General Motors, and Tesla in America. Toyota, Honda, and Nissan are from Japan. Daimler (Mercedes Benz), BMW, Porsche, and Volkswagen are from Germany. Stellantis is the new name of the auto firm that combines Fiat, Chrysler, and Peugeot. Some of Stellantis’ sub-brands include Jeep, Dodge, Ram, Alfa Romeo, and Maserati. Tata Motors in a leading Indian-based auto manufacturer, which also owns Jaguar and Land Rover. China's leading auto companies, SAIC Motor, Dongfeng, FAW, Chang'an, BYD, Chery, and Geely, may someday become known on a global scale. Geely is already known outside of China, mainly due to their acquisitions of Volvo and Lotus. Speaking of cars, you may not need one anymore with Uber and Lyft, ride-sharing services, now available around much of the word and also two publicly traded stocks. Uber and Airbnb, a home rental firm, are leaders of what is known as the “sharing economy.”
We mentioned some large American financial firms, such as J.P. Morgan and Goldman Sachs, that are in the Dow. Their main American competitors include Bank of America, Citigroup, Wells Fargo, and Morgan Stanley. Some overseas competitors include Bank of China and the Industrial and Commercial Bank (ICBC) of China, Deutsche Bank of Germany, Union Bank of Switzerland (UBS) and Credit Suisse (both Swiss Banks), and Barclays, a British bank. BlackRock and Vanguard are the two largest asset managers in the world, primarily running mutual funds and exchange-traded funds for their customers. Both manage in excess of $6 trillion in assets.
Congratulations, you now have literacy in many of the leading publicly traded firms of the day! Of course, there are a bunch of firms that are currently private such as Fidelity Investments (financial services) and Cargill (agricultural services) that are important too. By following the business press or financial websites such as WSJ.com, Yahoo! Finance, Google Finance, Bloomberg, CNBC.com, and MSN Investor, you can keep up to date on these firms and the new ones that will inevitably emerge.