Quite often I say that I don’t like the Dow Jones Industrial Average as an indicator of large capitalization stocks in the United States, instead preferring the S&P 500. Here’s something that happened last week that will give you a little more insight to that opinion:
Last week there was a change in the composition of the ‘venerable’ Dow Jones Industrial Average (which is composed of only 30 stocks). General Electric is being removed after a 111-year run and is being replaced by Walgreens Boots Alliance on June 26. GE was part of the initial Dow group in 1896, and was kicked out and re-added a few times in the early 1900’s prior to its current run. GE’s poor performance during an internal restructuring as of late may have played a role, but, officially, it appears the Dow is adjusted based on its intention to be a bellwether for a group of leading stocks that best represent the U.S. economy at the time. The addition reflects a larger contribution from consumer and health care, while the impact of industrials has declined. Some were wondering why Amazon wasn’t the new name added, due to its size, scale and clout, but maybe that’ll be next. The Dow folks have generally been a bit late to add technology, perhaps due to their over-representation on the Nasdaq. Another factor in the change could be related to the historical quirk of its ‘price-weighted’ construction scheme—the chairman of the index committee last year noted that they prefer the ratio of the highest priced to lowest priced stock in the index to be less than 10 to 1. Again, the antiquated format of the index’s construction render this an issue where it shouldn’t be—other indexes are market cap-weighted or use another easily calculated scheme. While the price-weighted construction no doubt assisted in the process of calculations done by pencil 1900, it makes very little sense today.