So I was poking around the Dow this week in putting together the piece that we ran today, subtly entitled 'Dow 18,500? Believe It', and started crunching a few numbers to gauge the index's exposure to non-U.S. markets.

While we here at 'Basis Pointing' have often been mockingly praised for our keen mastery of the obvious, I was still stunned by the sheer volume of business that these firms are doing abroad. To wit, here's the percentage of net revenue that the Dow's top-eight names realized outside of the U.S. in 2006:

• IBM  |  61%
• XOM  |  69%
• BA  |  49%
• MMM  |  61%
• MO  |  58%
• UTX  |  51%
• CAT  |  53%
• PG  |  57%

So what's the takeaway? To my mind, the time has come for indexers to rethink the way they're constructing domestic and foreign stock indexes. Out with 'domicile', in with 'economic substance'. It's the economic exposure we're seeking anyway. So why not tie inclusion criteria to provision or consumption of the services and products that these firms offer? If we built indexes on that basis, then the focus would rightly shift to sussing-out which geographic locales a firm earned its revenue in.

Of course, you could make the counterargument that if it's economic exposure we're seeking to gauge, then we should focus on where enrichment takes place. By that rationale, if a firm manufactures its products in the U.S., ships them abroad, and any revenues are remitted back to the States, then the real economic substance--the conversion of goods or services into monetary profits--has taken place on U.S. soil.

Yet, upon closer examination, it becomes plainly evident that these firms operate on a truly global scale. Take P&G, for example. In 2007, a mere $73.5 billion of the company's $138 billion in total assets were based here in the U.S. (yeah, you've got to remove goodwill/intangibles to get a feel for where the fixed assets are, not that I'd expect that to alter the conclusion any). What's more, as of June 30, 2007, P&G had a cool $17 billion in net profits sitting on the books of its foreign subsidiaries, where they're likely to remain for a veeeeeery long time (the words used in the 'Income Taxes' footnote of P&G's most recent 10-K are 'indefinitely invested'). This lends credence to the view that the economic event--profit creation--is taking place abroad. Yet, P&G and a number of the other Dow components are routinely lumped into domestic indexes.

Granted, the reverse is true of foreign-domiciled firms that do lots of business here. Siemens, Sony, Toyota Motors, HSBC, Glaxo, and the list goes on. So, it cuts both ways. But the point is--a system that uses domicile to divvy firms between the foreign and domestic camps is increasingly passe. There's gotta' be a better way.

I know, I know...it's not like we can neatly cleave P&G into its foreign and domestic pieces. But it certaintly seems like there's an opportunity for fundamental indexers--I'm looking at you WisdomTree--to take on this challenge. How might a solution work? We've seen a number of dividend- and earnings-weighted schemes, in which indexes weight stocks not by market-cap, but by the cash value of dividends they pay or profits they churn. So, what about a foreign-revenue or foreign-profit weighted fundamental index?

Perhaps inclusion would be determined based on the percentage of revenue or profit a firm earned abroad. From there, one could weight each name based on the dollar value of revenue and profit earned during a given year. That would effectively prevent smaller-caps, which tend to be more-provincial by their very nature, from dominating the index. And, voila!...a pure (or at least purer, if there is such a word) foreign index is born.

It stands to reason that there would be a companion "U.S." index, constructed in a similar manner, to complement the pure foreign index I'm describing. The tough nuts to crack are the global firms like P&G, though that challenge seems surmountable (for instance, scale the position sizes somehow, etc.).

Of course, global reporting standards will have to catch-up to make this a reality. Many foreign firms, for instance, don't segment their revenue and profit by geographic locale. But if investors rally around the idea, the reporting challenge will take care of itself.