Most investors see the Dow Jones Industrials as among the safest blue-chip stocks in the entire market. But some of the Dow's 30 components are riskier than others, and just because a stock is in the Dow doesn't mean that it's invulnerable to market reversals. Own the wrong stocks when the market starts to decline, and you could magnify your losses.
One way of measuring the risk of a stock is by looking at its share-price volatility. Using a metric called beta, you can see which stocks have had the biggest rises and falls in response to changing market conditions in the past. By that measure, let's look at the five riskiest Dow stocks over the past five years.
Bank of America , beta = 2.40
The fact that Bank of America tops the list of riskiest Dow stocks should come as no surprise. B of A was one of the hardest-hit banks during the financial crisis, as its buyouts of Countrywide and Merrill Lynch greatly heightened the risks it had already taken in its own core banking operations. Even now, the bank has a leverage ratio of 9.3, which is more than many of its domestic traditional-banking peers.
Still, B of A has taken many steps to get less risky in recent years. Passing the Federal Reserve's stress tests earlier this month shows how far B of A has come, and even with $5 billion in share buybacks coming, the bank's decision not to increase its dividend will leave Bank of America in a more stable capital position as it continues to earn profits and bolster its balance sheet.
Alcoa , beta = 2.10
The commodity space has always been risky, as business cycles push various commodities in and out of favor. Aluminum has been one of the most volatile of commodities in recent years, as changing global economic conditions in the construction and infrastructure industries have sent industrial metals rising and falling sharply. With major Chinese aluminum producers getting subsidies to boost production despite low prices, Alcoa suffers the consequences of a glut of supply on the global market.
Still, Alcoa has taken steps to maximize its eventual benefit when the business cycle turns higher. Seeking strategic acquisitions and looking to build partnerships with China, Alcoa could turn its woes into greater profits when the tide turns.
Caterpillar , beta = 1.91
Caterpillar is similarly exposed to world economic conditions. As the giant in the construction-equipment industry, Caterpillar needs healthy economies around the globe to support its business. Yet lately, higher competition and weaker activity levels, especially in China, have hurt the company. As far out as 2015, Caterpillar remains skeptical of its ability to grow to its maximum potential.
Still, because of Caterpillar's global breadth, it may be able to avoid the full brunt of a stock-market downturn if that downturn is caused by domestic considerations. Caterpillar does do substantial business within the U.S., but the benefit of global diversification can help in anything short of a global stock-market collapse.
American Express, beta = 1.80
American Express had to deal with the recession and financial crisis in much the same way as regular banks. With credit risk from its charge cards and falling transaction volumes during the economic slowdown, AmEx is tightly connected to the health of the economy.
Yet AmEx is doing its best to broaden its appeal beyond its traditional core base of wealthy customers. Its Bluebird prepaid debit-card initiative is aimed squarely at lower-income customers, with the capacity to generate brand new revenue and get its products in front of new faces. Prepaid cards are a highly competitive business right now, so AmEx still has plenty of risk, but it has a strong brand behind it in its drive for success.
General Electric , beta = 1.63
General Electric was another near-casualty of the financial crisis, with the conglomerate's GE Capital overwhelming GE's traditional core industrial business. Since then, though, the company has bounced back by returning to its roots and moving forward in lucrative directions, including energy infrastructure.
In some ways, having a purer industrial focus leaves GE more vulnerable to the cyclical nature of its business. But given GE's success even in a relatively unfriendly environment for industrial stocks worldwide, faster global growth could make the stock truly soar.
One thing to be aware of in considering these stocks is that beta is a backward-looking measure. Although it's reasonable to assume that stocks that have been risky in the past will continue to be risky in the future, that's not an ironclad certainty looking forward. Nevertheless, being aware of the risks involved in every stock will leave you better prepared to handle inevitable future market downturns.
Risky or not, Bank of America's stock doubled in 2012. Is there more yet to come? With significant challenges still ahead, it's critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool's premium research report on B of A, analysts Anand Chokkavelu, CFA, and Matt Koppenheffer, financials bureau chief, lift the veil on the bank's operations, including detailing three reasons to buy and three reasons to sell. Click here now to claim your copy.
The article The 5 Riskiest Stocks in the Dow originally appeared on Fool.com.Fool contributor Dan Caplinger owns warrants on Bank of America. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends American Express. The Motley Fool owns shares of Bank of America and General Electric. 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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