Aug 27, 2020 - Economy & Business

How the Dow masquerades as a stock-market index

Illustration of a magnifying glass showing the U.S. flag with stock market numbers in the background

Photo illustration: Sarah Grillo/Axios. Photo: Johannes Eisele/AFP via Getty Images

For all its weakness as a stock-market gauge, the Dow Jones Industrial Average continues to tell us a lot about the state of corporate America, as opposed to the state of the equity market.

Why it matters: The Dow is a slice of America masquerading as a stock-market index.

How it works: The Dow is not what it used to be.

  • I mean that literally: The Dow Jones Industrial Average has had 30 components since Oct. 1, 1928. As of this Monday, none of the original companies will be represented in the average.
  • The Ship of Theseus has now officially sailed: The last surviving member of the original 30, ExxonMobil (f/k/a Standard Oil of New Jersey), is being ejected from the index in favor of Salesforce, a company founded in 1999.
  • ExxonMobil's rival, Chevron (f/k/a Standard Oil of California), still remains, but that's it for energy companies. Chevron accounts for a mere 2% of the Dow, which is weighted on nominal share price rather than market capitalization.

Because nominal share price matters so much to the Dow, Apple's recent decision to do a four-for-one stock split forced the biggest changes to the average since at least 2013. Pfizer and Raytheon are also out; Amgen and Honeywell replace them.

Between the lines: The Dow has accepted Nasdaq-listed companies since 1999, when Microsoft and Intel joined. But tech giants of more recent vintage are still absent.

  • Amazon and Alphabet can't join because their share price is too high, and Facebook is a victim of its classification as "communication services" rather than "technology."

The big picture: The Dow is anachronistic in many ways, a creature of a time when it was easier to buy 30 stocks than to buy 500, and when "I'll take one share of each" was the height of sophistication in how people diversified their holdings.

  • Still, the Dow represents a representative cross-section of America's large-cap universe, including names such as McDonald's, JPMorgan Chase, Walt Disney, Coca-Cola, Nike, and Procter & Gamble.

The bottom line: The Dow has been a notorious underperformer in recent years, when it comes to stock market indices. But if it can't keep up with the stock market as a whole, that's a sign of just how narrow the recent advance has been.

How the Dow has lagged

Data: FactSet; Chart: Axios Visuals
Data: FactSet; Chart: Axios Visuals

Even with Apple accounting for more than 12% of the Dow, the average has underperformed all broad stock market indices this year.

  • After its stock split, Apple will account for less than 3% of the Dow.
  • From Monday onwards, two of the three biggest Dow components will be healthcare companies. UnitedHealth and Amgen will make up almost 13% of the Dow between them.
  • Merck and Johnson & Johnson bring the health care sector up to 18.6% of the Dow. That's significantly larger than the S&P 500, where the health care sector is 14.2% of the index.
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