Stocks: Understanding the reshuffled Dow

The Dow Jones industrial average is getting a new look, said Neil Irwin in WashingtonPost.com. Among the index’s 30 constituent companies, “Alcoa, Hewlett-Packard, and Bank of America are out. Nike, Visa, and Goldman Sachs are in.” But despite that change, the Dow remains a pretty useless measure of the stock market. No 30 stocks can adequately represent corporate America, particularly since the Dow weights each stock “not based on the size or importance of the company, but by its per-share price.” That had some logic when people had to calculate an index’s value by hand, but “the per-share price of a stock has absolutely nothing to do with its size, importance, or representativeness.” Bank of America, for example, is much larger and more engaged in the American economy than Goldman Sachs’s specialty investment-banking business. It did make sense for the Dow to jettison Alcoa, which “has been a relatively small company for years, no longer what one would consider to be among the 30 most important companies or stocks.” But the real question is, “what took so long?”

Even the index’s name is a misnomer, said Binyamin Appelbaum in NYTimes.com. The era of industrial manufacturing is dead and gone, “and the Dow Jones long ago started replacing industrial bellwethers with banks and big-box retailers.” By my count, the new index will include 15 nonindustrial companies, including American Express, JPMorgan Chase, Home Depot, McDonald’s, Walmart, the Walt Disney Co., AT&T, IBM, Verizon Communications, and Microsoft. In 1978, there were only three: Sears Roebuck, Woolworth, and AT&T.

The changes haven’t stopped the Dow 30 from becoming “an overrated symbol,” said Derek Thompson in TheAtlantic.com. By limiting itself to just 30 companies, it creates a revolving door, “constantly hauling new companies into the boat before casting them overboard.” Broader baskets like the Standard & Poor’s 500 and the Wilshire 5000 are far better representations of today’s economy. The once important Dow is today “a better time capsule” than it is an index.

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Maybe so, said Dan Caplinger in DailyFinance.com. But “for millions of Americans, the Dow Jones industrial average is the primary way they keep track of what’s happening with the stock market.” They should not “automatically follow the Dow’s moves.” The reshuffling doesn’t mean Nike, Visa, and Goldman Sachs are good buys, or that it’s time to sell off your Bank of America and HP shares. It does mean that since Visa and Goldman trade at such high share prices, “the Dow’s fortunes will be much more closely linked to that of the financial industry.”