The Dow Jones Industrial Average consists of 30 of the most dominant companies in America and is the oldest and most widely quoted stock index. After the close of trading on Sept. 20, there will be some significant changes made to the Dow lineup.
Alcoa, Hewlett-Packard and the Bank of America will get deleted from the Dow, and Visa, Nike and Goldman Sachs will be added. Alcoa has been a part of the average for 54 years now.
Changes to the Dow are fairly common. In 2009, Citigroup was replaced by Travelers Insurance, and Cisco was added in place of General Motors. In 2008, Kraft Foods replaced AIG.
The Dow was originally calculated in 1896 and was invented by Charles Dow. Initially, the average was calculated as an arithmetic average, where you simply added the prices of the 30 stocks, then divided them by 30 to obtain an average price.
Since 1896, the divisor has been continually adjusted lower to account for stock splits and spin-offs. Today, the divisor is so low it acts as a multiplier; the number has been adjusted down to about 0.13 from the original 30.
The Dow isn’t really an industrial average anymore, either. Today’s Dow consists of technology stocks like Cisco, Intel and IBM; energy stocks like Chevron and Exxon-Mobil; pharmaceutical stocks like Merck, Pfizer and Johnson & Johnson; and financial stocks like American Express, Goldman Sachs, JP Morgan and Travelers.
Conglomerate General Electric is the oldest member of the Dow, having been part of the index for more than a hundred years, since 1907. The Dow needs to be changed periodically to keep up with the changes in our ever-evolving economy, so that the average represents America’s leading corporations.
The Dow is a price-weighted index, which means that the stocks in the index are weighted according to their share price. Conversely, the S&P 500 index is a capitalization-weighted index, which means the companies in the S&P 500 are weighted according to their market cap, so the larger the company is, the more representation it will have in the index.
Market cap is defined as the number of outstanding shares of stock times the stock price. Large companies like Apple and Exxon-Mobil will have more representation in an index like the S&P 500. The S&P 500 consists of 500 of the largest companies in America, so it is much broader based than the Dow.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.