Change is inevitable, even when it comes to the 125-year old Dow Jones Industrial Average.
At the end of August, the Dow underwent a major change by switching out some of the companies it has been tracking.
|Honeywell International||Raytheon Technologies|
S&P Dow Jones Indices, the company that manages the Dow, said that Apple’s 4-for-1 stock split on August 28 was the main reason for these changes.
But how did the stock split affect the Dow?
Generally, investment indexes have rules for determining the weighting of each company (also called a constituent) that they track. The Dow uses price weighting; that is, each company’s share price determines its relative weight in the index. The higher the company’s share price, the larger the weight it has in the index.
Apple’s 4-for-1 stock split resulted in each investor getting three additional shares for every share that they owned as of the date of the split. Also, Apple’s share price was divided by four–meaning that the company’s stock is now much cheaper. This would have greatly decreased the Dow’s exposure to companies in the information technology sector.
The addition of Salesforce.com serves two purposes:
First, it has boosted the Dow’s exposure to information technology, post-Apple-stock-split. Second, it also provides some additional exposure to a different sub-sector within information technology—namely, business services (as opposed to Apple’s premium retail products).
Still, that doesn’t explain why Salesforce.com has replaced Exxon Mobil—which was also the Dow’s oldest constituent (it was added to the Dow in 1928 in its previous life as Standard Oil).
The reason for Exxon Mobil’s removal is the overall slump in the energy sector, which began in 2014. The Dow is intended to broadly represent U.S. industry, but energy has lost a big amount of market share, while information technology has expanded dramatically. The only energy company in the Dow is Chevron.
The other company changes are more straightforward. Honeywell’s broader industrial footprint reaches beyond Raytheon’s focus on aerospace and defense. The company also has a higher stock price, so the industrials sector’s weighting in the Dow has increased.
Replacing Pfizer with Amgen will help to diversify away from traditional pharmaceutical companies and toward biotechnology (the Dow still contains Johnson & Johnson and Merck & Co.). Amgen’s stock price is also higher. This means that the healthcare sector’s weight in the Dow has increased.
Will these changes affect your portfolio?
The short answer: probably not. Since you can’t directly invest in an index itself, any impact to your portfolio should be limited, unless you invest in a strategy designed to track the Dow.
Many investors believe that other indexes provide better representation of overall market performance. After all, the Dow only tracks 30 ultra-large U.S.-based companies…just a tiny portion of the global market.
For performance benchmarking, market-capitalization-weighted indexes (such as the S&P 500 Index) replaced the Dow’s price weighting a long time ago. Market-cap indexes use a rather straightforward logic to basing the relative index weights of companies on their overall market value.
Still, news outlets often breathlessly announce dramatic-sounding changes to the Dow. After all, reporting a 280-point drop tends to garner more attention (and perhaps panic) than reporting a decline of 1%.
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