Forbes - August 31, 2020
The Dow is now down an oil behemoth. Along with ExxonMobil ( XOM ), the integrated energy giant, the Dow Jones Industrial Average (DJIA) has jettisoned Pfizer ( PFE ) and Raytheon Technologies
( RTX ), replacing them with Salesforce.com ( CRM ), Amgen ( AMGN ), and Honeywell International ( HON ), respectively.
This is the first shake-up in the 30-company index since the S&P Dow Jones Indices, which manages the Dow, substituted Walgreens Boots Alliance ( WBA ) for General Electric ( GE ) in 2018.
The S&P Dow Jones Indices made the swap after Apple ( AAPL ), the nation’s largest company, instituted a four-to-one stock split. While the move won’t affect the valuation of the iPhone maker, it will upset the balance of the Dow since it is weighted by stock price. Apple will go from the most heavily weighted stock in the Dow to a middle-of-the-pack 17th. The new top three will be Unitedhealth Group ( UNH ), Home Depot ( HD ), and newly added biomedical firm Amgen.
“To some degree, the impact on the Dow of the split is similar to profit-taking, since the gains are locked in and then reallocated into the portfolio,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, in an email to Forbes Advisor.
What Is the Dow Jones Industrial Average?
The Dow Jones Industrial Average, aka the Dow, is an index of 30 of the largest companies in the United States that’s used as a barometer for the wider stock market as a whole.
First created in 1896 by Charles Dow, Edward Jones, and Charles Bergstresser, the index moved to 30 companies on October 1, 1928, and began using a divisor, which is continuously updated, to account for stock splits, dividends and membership changes. To calculate the Dow Jones Industrial Average you add up the prices of all the member stocks and divide by the divisor.
The Dow, then, is weighted by the price of a stock rather than its market capitalization, a metric used by the Dow’s biggest rivals the S&P 500 and the NASDAQ. Combined with a relatively low number of companies (30 vs. 500 in the S&P 500, for instance) the Dow can experience the vicissitudes of the market more severely than other indices.
Why Is The Dow Changing Now?
Apple is so big that its stock split will reduce the technology sector’s weighted average in the Dow by about 7 percentage points. Apple itself will decline from a pre-split weighting of just over 12% to about 3%, according to Silverblatt.
To compensate, the Dow is replacing ExxonMobil with software company Salesforce.com. Exxon gained admission to the Dow as Standard Oil of New Jersey when it expanded to 30 companies back in 1928. With Exxon’s exit, Chevron ( CVX ), which was added in 1924 as Standard Oil of California, now becomes the sole representation of the energy sector. Exxon, along with Pfizer and Raytheon, has struggled so far this year. The S&P Dow Jones Indices decided to replace Pfizer and Raytheon with companies that will increase the index’s exposure to health care (in Amgen) and offer diversification in the industrial sector (in Honeywell).
What Does The Dow Change Mean For Investors?
The point of the change isn’t to recommend investors buy or sell a particular company. Rather, it reflects the reality of the market as a whole.
“The bottom line is that the marketplace is always changing, and market barometers need to change with it,” wrote Silverblatt in a blog post. “Each of the changes reflects the environmental changes of the economy and is not intended as a buy-sell indicator, but as a ‘that’s the way it is’ reflection of the market.”
Instead, investors may want to use this occasion to reconsider whether the Dow makes sense as a barometer, at all.
“The Dow is still the most popular and widely used index when referring to the market however, I find it difficult to believe in 2020 that 30 companies can be representative of the entire economy, particularly if it is solely reflected and measured by the share price of those companies,” said Nicholas Chiricosta, founder of Utopia Wealth Management.
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