Cleaning House: Why the Dow is Making Changes

Why the DOW is Making Changes

By Matt Billings, SVP of Trading Services and Guest Blogger

The Dow Jones Industrial Average is the oldest and most discussed stock index in the world. So it piqued the interest of investors when it was announced that the DJIA (or “Dow”) would undergo its first change since 2004. Starting Sept. 23, three of the 30 stocks making up the index – Hewlett-Packard Co., Alcoa Inc. and Bank of America Corp. –will be replaced by The Goldman Sachs Group Inc., Visa Inc., and Nike Inc.

To understand the impact of this change, it’s worth understanding a bit about the Dow. Invented in 1896 by Charles Dow to assist investors with their investing and trading, the DJIA today is of a price-weighted average of 30 stocks that are typically viewed as economic leaders.

Stocks Included in the Dow
The stocks selected for the DJIA are chosen by an Index Committee for S&P Dow Jones Indices. The index covers all industries except Transportation and Utilities-those sectors are reserved for the Dow Jones Transportation Index (DJTI) and the Dow Jones Utilities Index (DJUI). While the DJIA is reviewed annually, changes are rare.

So why were changes made this time around? In a press release, S&P Dow Jones indicated that a key factor was the stock price of the three deleted companies. As a price-weighted index, lower-priced stocks have less impact on Dow than higher-priced stocks. The companies picked for deletion were the lowest-priced stocks in the Dow at the close of the market on Sept. 10 when the change was announced.

By contrast, two of the three stocks added, Visa (V), and Goldman Sachs (GS) would have been the second and third highest DJIA stocks as of the Sept. 10 market close. Nike (NKE) would have been in the middle. According to DJIndexes.com, a stock typically is added only if it has an excellent reputation, is of interest to a wide number of investors, demonstrates sustained growth and accurately represents the sector(s) covered by the average. In addition to the low price of the three companies deleted, S&P Dow Jones also said the move was prompted by a “desire to diversify the sector and industry group representation of the index.”

With the change, the Dow will have the following stocks:

MMM, AXP, T, BA, CAT, CVX, CSCO, KO, DD, XOM, GE, HD, INTC, IBM, JNJ, JPM, , MCD, MRK, MSFT, PFE, PG, TRV, UTX, VZ, WMT, DIS, UNH, GS, V, NKE

Impact of the Change
When the three new stocks are added, the price of the Dow will not immediately change. Instead S&P Dow Jones will change a divisor that was used to even out of the effects of changes in the components of the index, along with stocks splits, spinoffs and stock substitutions.

However, the three new stocks could have a greater impact on the movement of the Dow than the three lower-priced stocks they replaced simply because of the math involved. A 1 percent movement in a stock selling for $180 share would have far greater impact on the Dow than a 1 percent movement in a stock selling for $18 per share.

Using the Dow
The average investor utilizes the DJIA as a general barometer of the markets.

If used as a yardstick, investors may use the Dow to track their own portfolio's performance on a monthly or quarterly basis. The DJIA can essentially be turned to as a "benchmark" for comparison purposes. When using the Dow as your “benchmark” one should be cautious. As previously noted the Dow is comprised of 30 companies, albeit very large conglomerates. The Dow is a more narrow representation of the market than other indices such as the S&P 500 which represents 500 companies.

Anticipating Trends

An advantage of using the Dow Jones Industrial Index is the diversity of its stocks. Overall, it provides a "market average" that lets you know how the companies trading in the stock market are performing on the whole. However, it can be disadvantageous because of that same reason-if you wish to learn more about a particular sector, this index likely will not provide enough insight for your analysis.

Quoting the Dow
In your Scottrade account, if you want to get a real-time quote for the Dow Jones Industrial Average or add the symbol to your Quote Grid in ScottradeELITE, type $DJI. To see all the stocks that make up the index listed individually, add a # sign (#$DJI) when using ScottradeELITE.

Matt Billings is senior vice president of Trading Services and Program Management at Scottrade, Inc., overseeing the routing and execution of equity and option order flow.


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