The Changing Dow

After the closing bell on September 20, Alcoa, Hewlett-Packard and Bank of America will be dropped from the Dow Jones Industrial Average. In what will be the biggest shake-up to the 30-stock index in nearly a decade, the three stocks will be replaced by Nike, Visa and Goldman Sachs.

The changes were driven by the low stock price of the three companies slated for removal, along with the Index Committee’s wish to diversify the Index’s sector and industry group representation. Unlike the market-cap weighted S&P 500, the Dow is a price-weighted index. Day-to-day movements in low-priced Dow stocks such as Alcoa (currently trading for around $8 per share) have little impact on the benchmark’s performance.

While the S&P 500 is a more widely used benchmark in the investment community, the Dow gets more media attention and is probably better-known to most individual investors.

It can be argued that if the Index Committee truly wanted the Dow to better reflect the current environment, it should have added a company such as Google or Apple. However, these two stocks currently trade at share prices of roughly $900 and $500, respectively, meaning they could have too big a sway on daily price moves. For example, at current levels, Apple would overwhelm the Dow with about a 25% weighting, or about double the effect of current Dow component IBM. On the other hand, Alcoa’s low share price causes it to have very little impact on the Dow. A 50% move in Alcoa would push the index up by only about 40 points.