A couple of weeks ago, the Dow Jones Industrial Average reshuffled some of its inner holdings:
- Goldman Sachs (GS)
- Nike (NKE)
- Visa (V)
- Bank of America (BAC)
- Alcoa (AA)
- Hewlett-Packard (HPQ)
When I was a kid, I always remember my dad coming home from work and turning on CNN/CNBC/BNN to catch the financial news for the day. Each broadcast would start with “Today in the market, the Dow Jones Industrial Average was up / down x / y points”.
It wasn’t until I got started into investing that I understood what the DJIA was – an index comprised of 30 US stocks that are publicly traded. The index works by basically taking the closing prices each day of the 30 stocks; and dividing it by a divisor – which doesn’t change unless a company is added or removed from the index. So, every day after work, my dad could get a sense for how the “market” was doing when hearing about the Dow Jones.
This all makes sense – investors need a way to get a summary view of how the market is doing – and indices provide that. Digging deeper into indices, and you’ll find that there are hundreds of different indices out there – following everything from type of industry to stock markets of other countries.
So, what does the addition / removal of these companies last week mean? Not a whole lot. We know that the DJIA consists of 30 companies – those 30 companies are determined by the S&P Dow Jones Indices (a joint venture between McGraw Hill Financial, CME Group, and News Corporation) – with the aim to represent a flavor of the biggest and best companies in the U.S. This list is arbitrarily decided by them – and with only 30 to pick, starts making you wonder:
- why Microsoft and not Google
- why Goldman Sachs and not JP Morgan
- why are there two oil companies (Exxon and Chevron) but no utility companies
- why American Express and not Mastercard
Anyways, I could go on and on. At the end of the day, the DJIA doesn’t mean much or really mean anything from a quantitative perspective. It’s a list of 30 representative stocks that some folks in a room can decide one day that one stock no longer represents the market (i.e. Bank of America); and replace it with another (i.e. Goldman). At least the other indices – i.e. S&P500 or NASDAQ 100 have specific rules around market capitalization, trading volume, available float, etc. allowing the index to be reshuffled each year as companies make or not make the list.
So, whenever someone asks what I think about the Dow hitting x, I ask them if they’re invested in those 30 companies, because that’s the only investors I feel it would be relevant to.