Earlier this week, the index committee of S&P Dow Jones
Indices decided to remove key companies from the Dow Jones
Bank of America Corporation
) will exit the index at the end of trading on September 20, when
the decision comes into effect.
These stocks will be replaced by
The Goldman Sachs Group, Inc.
) which will feature on the index in their place when trading
starts on September 23. This is the most significant such move
since April 2004. On that occasion,
), Eastman Kodak and
International Paper Company
) had exited the index. They were replaced by
American International Group, Inc.
Verizon Communications Inc.
The Rationale Behind the Changes
The reason for the changes was outlined clearly by David Blitzer,
managing director and chairman off the index committee. The Dow
is a price-weighted barometer. This means that the higher the
price of a company on the index, the larger its weight. This is
significantly different from indices which weight their
components on the basis of market capitalisation, such as the
The companies being removed are amongst the lowest in the index
on the basis of price. They continue to be important
multinational corporations, but their stock prices has fallen to
an extent that they contribute to only 3% of the total average,
according to Blitzer. Such changes were, therefore, inevitable
considering the rationale on which the index is based.
The Fortunes of Those Making an Exit
With prices ranging between $7 to 8 per share, Alcoa is easiest
amongst the lowest priced among those being removed. Most
importantly, the U.S. economy has moved away from being dependent
on heavy manufacturing towards sectors such as technology,
finance and healthcare.
The company will remain largely unaffected by the Dow's decision.
But it will affect the image and prestige of a corporation,
struggling to combat wildly fluctuating prices by focussing on
value added sales to the automotive and aerospace sectors.
Bank of America
The fact of the matter is that the aluminium producer never
recovered from the recession of 2008. The case is more or less
similar for Bank of America. Since then, it has been trying to
reduce the size of its business. It has also been dealing with a
large number of legal problems arising from its purchase of
Countrywide Financial in 2008.
Even though the share price of this stock is still below the
levels it achieved before the crisis, it has trended upwards last
month. Last year, the share price had doubled. In this case as
well, there will be no financial impact from this decision. But
the bank is a long way from achieving the success it did before
This was the second computer firm to be added to the index in
). At this point it is facing various business challenges, even
though its stock price has increased by more than 50% this
year. One example of its problems is the enormous
write-down it had to make last year after its unfortunate
purchase of British software firm Autonomy.
The more disastrous acquisition, that of Compaq, occurred even
earlier. This purchase meant that the company continued to focus
on PCs while the world moved on to smartphones and tablets. Even
in its chosen domain, it has little proprietary technology of its
The Impact on the Index
Even though it is only a thirty stock index, the Dow is still
considered to be an important barometer of the economy. The idea
behind the changes seems to be an attempt to make the index more
representative of the financial markets as a whole.
The Dow has been criticized for being a price weighted index, but
that is another matter altogether. The major issue weighing on it
for some time now was that it was being heavily dominated by some
stocks, primarily IBM, priced at $185 a share and making up 9.43%
of the index.
The components being removed have an average share price of $15.
On the other hand, those being added are priced at an average of
$134.50 a share. Goldman Sachs, Visa and Nike will now make up
17.4% of the index.
The excessive dominance of IBM on the index is why these
inductions have been made, says Blitzer. This is also why the
likes of Apple and Google have been left out. Blitzer feels they
would bring in even larger distortions due to their share prices.
Ultimately, the Dow's decision has been one of the signature
events for financial markets this year. Many may question the
Dow's rationale for such decisions. But ultimately it remains a
significant barometer for the economy. Any move to make it more
representative is, therefore, a welcome one.
ALCOA INC (AA): Free Stock Analysis Report
AMER INTL GRP (AIG): Free Stock Analysis
BANK OF AMER CP (BAC): Free Stock Analysis
GOLDMAN SACHS (GS): Free Stock Analysis
HEWLETT PACKARD (HPQ): Free Stock Analysis
INTL BUS MACH (IBM): Free Stock Analysis
INTL PAPER (IP): Free Stock Analysis Report
NIKE INC-B (NKE): Free Stock Analysis Report
PFIZER INC (PFE): Free Stock Analysis Report
AT&T INC (T): Free Stock Analysis Report
VISA INC-A (V): Free Stock Analysis Report
VERIZON COMM (VZ): Free Stock Analysis Report
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