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Four Stocks Changed In DJIA

News

On March 12, Dow Jones & Co. announced that it was adding four stocks to the Dow Jones Industrial Average (DJIA) index, and removing four others. The additions are some of America's most eminent, and successful, companies.

The decision to alter the makeup of the Dow was ‘triggered’ by Westinghouse's recent decision to spin off its industrial units, leading to a larger re-evaluation of its competition. (NYT, March 13, 1997)

Joining the select group are Hewlett-Packard from technology, Johnson & Johnson from health care, the Travelers Group from financial services, and Wal-Mart Stores, the giant retailer. Departing the index are Bethlehem Steel, Texaco, Westinghouse Electric and Woolworth.

Analysis

I would like to take this opportunity to look at the advantages and disadvantages of some of the more widely used market barometers.

DJIA
Let’s start with the Dow:

The index is calculated as the sum of the prices of the 30 blue chip stocks comprising the index (see below) divided by a number called the "devisor" which adjusts for stock splits and spin-offs.

Currently the "divisor" is 0.32481605, according to the WSJ. Here is how it gets adjusted: For simplicity, consider a stock split. Say three stocks are trading at $15, $20 and $25; the average of the three is $20. But if the company with the $20 stock has a 2-for-1 split, its shares are suddenly priced at half of their previous level. That doesn’t mean that the value of the investment has changed; rather, the $20 stock simply sells for $10, with twice as many shares outstanding. Accordingly, the average of the three stocks falls to $16.66. Thus, the divisor is adjusted to keep the average at $20 and reflect the continuing value of the investment represented by the index.

The index has been criticized for the following:

1. It provides inadequate representation of the U.S. equity market as it only considers the largest 30 industrial stocks. Thus, it is not well diversified to include a broad cross-section of stocks. For example, utilities, transportation, and software companies are not included.
2. The prices are not market-weighted to reflect the size of the company as measured in terms of market value. For example the Journal provides the following example: "a stock such as United Technologies Corp. constitutes only 0.26% of the S&P 500. Yet it accounts for a whopping 5.5% of the Dow Jones industrials, because it is one of the most expensive stocks in the Dow."

How Do You Calculate the Size of the Impact of an Individual Stock on the Overall Index?
Divide the stock's price change by the divisor to see how many points that issue contributed to the change in the index on any day. For instance, IBM stock fell $1.125 a share on March 12. Dividing that by the current divisor shows that IBM accounted for 3.46 of the Dow's 45.79-point decrease.

Standard & Poor’s 500 (S&P 500)
The S&P 500 was designed by Standard and Poor’s Corp. to overcome the above two shortcomings. Thus, they include the largest 500 companies in the U.S., including those that trade on the NASDAQ exchange. Moreover, the index gives company prices weights in relation to their market value; the larger the value, the bigger the weight.

Wilshire 5000
This index, created by Wilshire Associates of Santa Monica, CA, originally comprised 5,000 stocks, thus the name. However, currently the index represents the price of more than 6,000 companies.

Russell Indexes (Frank Russell Co., Tacoma, Washington)
Russell 3000: Comprises the largest 3,000 stocks
Russell 2000: The smallest 2/3 of the Russell 3000. This has been a widely used barometer for small companies.

The following is the list of the 30 companies of the DJIA:

   1.     Alcoa 
   2.     Allied Signal 
   3.     American Express 
   4.     Boeing 
   5.     Caterpillar 
   6.     Chevron 
   7.     DuPont 
   8.     Disney 
   9.     Kodak 
  10.     General Electric 
  11.     General Motors 
  12.     Goodyear 
  13.     Hewlett-Packard
  14.     IBM 
  15.     International Paper Co. 
  16.     J.P. Morgan 
  17.     Johnson & Johnson
  18.     Coca Cola 
  19.     McDonalds 
  20.     3M 
  21.     Philip Morris 
  22.     Merck 
  23.     Procter and Gamble 
  24.     Sears 
  25.     AT&T 
  26.     Travlers 
  27.     Union Carbide 
  28.     United Technologies 
  29.     Exxon 
  30.     WalMart

By Alex Tajirian