The New Dow Jones Industrial Average

Since its inception in 1896, the Dow Jones Industrial Average has served as a barometer of the U.S. stock market by tracking a select group of the country's industrial leaders. Earlier this week, S&P Dow Jones Indices announced that  Visa,  Nike and  Goldman Sachs will replace  Hewlett-Packard,  Alcoa, and  Bank of America in this iconic index, effective Monday, Sept. 23. Because the index weights its constituents by their share price, rather than by market capitalization, these changes will have a significant impact. Both Visa and Goldman Sachs currently trade above $150, which will make them two of the index's top three holdings. They will also help take some of the weight out of  IBM, which currently represents more than 9% of the index. In contrast, the three departing stocks account for less than 2.5% of the index combined.

Price weighting is a relic from the 19th century that was adopted primarily because limited computing power made alternatives impractical. This simple price averaging approach that gives higher-priced stocks larger portfolio weights does not have a sound economic basis.

The index construction methodology does not follow mechanical rules, so there are no firm guidelines dictating how or when the committee overseeing the index will pick new constituents.

Although price weighting leaves something to be desired, the Dow tracks a fairly diverse set of top-quality companies that approximates the industry composition of the U.S. stock market.

Source:  Morningstar

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 

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