The index committee that runs the S&P Dow Jones Indices is
making changes to the stocks components within the Dow Jones
Industrial Average (NYSEARCA:DIA). Instead of being a broad
measure of the U.S. stock market, the changes appear to be more
about controlling the DJIA's price movements than any real
The committee is adding Visa (
), Nike (
), and Goldman Sachs (
) while dropping Alcoa (
), Hewlett Packard (
), and Bank of America (BAC) from the Dow Jones Industrial Average
How does one explain dropping a much larger company that has a
much bigger consumer footprint like Bank of America, for a much
smaller, much more specialized company from a similar industry,
such as Goldman Sachs?
Based on S&P's Index Committee Chairman, David Blitzer, it
is explained by reminding us, "There's no intention to pick
winners. Adding a stock or dropping a stock is not an
investment recommendation. It is done to improve the index
and make it a better indication of the market overall."
But actions speak louder than words my friends and the
Committee's actions are raising extremely large red flags for this
market strategist. I fail to see any "better indications of
the market overall" in the upcoming move.
The reason these particular stocks are being added is because of
their significantly higher price points and thus larger upside
potential for the Dow's price. Period.
A Bank for a Bank?
There will soon be zero traditional banks left in the Dow Jones
Industrial Average. Citigroup was removed in 2008 (likely for
similar "too low a share price" reasons) and when Bank of America
is booted the weekend of Sept 21, there will be zero traditional
Not only are there now going to be zero traditional banks, there
are going to be two investment banks, the other one JP Morgan
(JPM). (If you think JPMorgan Chase is a traditional bank
then please review the "London Whale" debacle).
Gold Experts are Misleading the Public
More so, there will now be two credit card transaction
processing companies, with American Express (AXP) the already
existing one in the Dow.
Are we really supposed to believe that the Dow will be more
representative of the market with zero traditional banks (when
combined hold over $10 Trillion in assets) but instead holding two
investment banks and two (of only four major) credit card
transaction companies? Last I checked, traditional banking
was still a much larger market than investment banking or credit
Below are some facts that should make you scratch your head when
trying to rationalize Bank of America's boot and Goldman Sach's and
Visa's inclusion (especially when you consider that JPMorgan and
American Express are already in the Dow):
Based on full year 2012 numbers, Bank of America has assets over
$2 Trillion. Goldman Sachs has around $900 Billion in
assets. Visa has a much smaller $40 Billion in assets.
Of note is that Wells Fargo's (also not in the Dow) assets (WFC)
are over $1.4T.
Bank of America has revenues over $100 Billion. Goldman
Sachs has around $34 Billion in revenue. Visa's revenue is
only around $10B. Wells Fargo has over $91 Billion in
Bank of America has a market cap around $157 Billion.
Goldman Sachs's market cap is around $77 Billion. Visa's
market cap is $119 Billion. Wells Fargo's market cap
meanwhile is over $225 Billion.
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As the fictional character Sherlock Holmes is quoted, "When you
have eliminated the impossible, whatever remains, no matter how
improbable, must be the truth". Anyway you slice it Bank of
America (and Wells Fargo) is at least two times larger than Goldman
Sachs and seems to be "a better indication of the market overall",
using the committee's chairman's words. Compared to Visa, it
is simply multiples times larger.
It is impossible to rationalize that Goldman Sachs and Visa are
more representative of the market than Bank of America (or Wells
Fargo), and that means there must be another truth.
The Real Reason for the Dow Change
Goldman Sachs is the 8th largest holding in the largest bank
ETF, the Financial Select Sector SPDR (NYSEARCA:XLF). The
largest financial company based on the S&P sector weightings is
Wells Fargo. Was it even considered for the Dow inclusion
instead of Goldman Sachs or Visa?
Bank of America is fourth, Citigroup (C) is fifth, and AIG (AIG)
is sixth. What do these companies not in the Dow or not even
considered have in common? All have share prices under
In contrast, Goldman Sachs has a share price over $160, and Visa
has a share price over $180.
In what may be a sure sign of performance chasing, the primary
reason Bank of America was dropped (and Alcoa and Hewlett Packard),
was because its price is too low to have much impact on the Dow due
to the way the Dow is calculated. Goldman Sachs and Visa
however will have major effects on the Dow going forward.
As a price weighted index, mathematically the companies in the
Dow that have higher share prices have much larger effects on the
index's price movements.
For instance when Goldman Sachs goes up 5%, its price moves up
$8; when Bank of America goes up 5% its price moves up only 80
cents...having approximately 1/10th the effect on the Dow's
price. By adding Goldman and Visa, the Dow Industrials will
feel the effects of these two company's price movements much more
Needless to say in a rising market, the Dow would much rather have
higher priced components, making the Dow rise faster and
farther. The drawback is this also leaves open the
risk of having a larger negative effect during a declining
The Committee Chairman admitted such in a roundabout way when he
commented on excluding very high priced companies such as Google
(NASDAQGS:GOOG) and Apple (NASDAQGS:AAPL) from the Dow. "The
prices of their stocks are so high that putting Google in would
completely distort the index and it wouldn't work".
The Reality of the Situation
All three of the companies that are being dropped from the Dow
have the three lowest prices of any of the 30 Dow components.
Coincidence? No way.
The table of the current 30 Dow components below puts this
reality into perspective and is why General Electric (GE), the only
original Dow Industrial Component remaining, should be worried that
it will soon be dropped by the Index.
Either that or the company will likely need to have a reverse
share split to take its equity price comfortably over the $70 mark,
the current median price for the 30 Dow Components.
ANALYZING DJIA COMPONENTS
Intel (NASDAQGS:INTC) and Cisco (NASDAQGS:CSCO) should also be on
the lookout for a letter from a Dow Committee that is much more
interested in the optics of a higher Dow price than a true
representative average of American companies.
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