The keepers of the Dow Jones Industrial Average have been very good at making sure the changes they make to the venerable stock-market barometer are seamless to investors, but nobody’s perfect.
How the 128-year old index
DJIA
is constructed is a secret closely guarded by S&P Dow Jones Indices. But some things, such as the influence each stock has, are known once changes are made.
There’s also the matter of the “Dow jinx,” which has seen new members tend to underperform the members they replaced.
The Dow is different than other market trackers, because the price is determined by dollar-amount changes in the components’ stocks. So stocks with higher prices — not companies with larger market capitalizations like those in the S&P 500 index
SPX
and the Nasdaq Composite Index
COMP
— have greater influence on the index’s price.
Rather than a weighting based on market cap, there is a “divisor,” or a number that a Dow stock’s price change is divided by to determine what effect that stock’s move has on the Dow.
As of Friday, that divisor was 0.15172752595384. That means that each $1 change in any of the Dow stocks moved the Dow’s price by 6.59 points.
On Monday, Walmart Inc.’s
WMT,
stock split will lower its price by two-thirds. And as of Friday’s close, the price of incoming Amazon.com Inc.’s stock
AMZN,
was roughly eight times the price of outgoing Walgreens Boots Alliance Inc.’s
WBA,
Also read: Why you can count on the Dow making changes in February
With those changes, the divisor increases slightly to 0.15265312230608, meaning the price changes of all the other Dow stocks will have a little less influence on the Dow’s price. For each $1 change, the Dow will now move by 6.55 points.
At Monday’s open, Amazon will be the third-largest company in the Dow by market cap, but will rank 17th out of 30 by price. A 1% change in Amazon’s stock would move the Dow by 11.5 points. But a 1% move in the Dow’s highest-priced stock, UnitedHealth Group Inc.’s
UNH,
which has about a quarter of Amazon’s market cap, would move the Dow by about 35.5 points.
The Dow keepers said the idea behind Monday’s change was to increase exposure to consumer retail, as well as other business areas. In effect, the keepers swapped a stock with a negative correlation to the market with one with a relatively high correlation.
For the past two years, the correlation coefficient between Walgreens’ stock and the Dow was negative 0.45, and between the stock and the S&P 500 it was negative 0.51.
Meanwhile, the correlation of Amazon’s stock with the Dow was 0.60 and with the S&P 500 it was 0.82.
S&P Dow Jones Indices also made a change to the Dow Jones Transportation Average
DJT,
by adding Uber Technologies Inc.’s stock
UBER,
while removing JetBlue Airways Corp.’s stock
JBLU,
Given that Friday’s closing price for Uber’s stock was about 12 times that of JetBlue’s, the Dow transports’ divisor increased to about 0.1673077 from 0.1627986.
Keep in mind that the Dow keepers aren’t trying to pick winners. Their mission is to match the market. And they’ve been pretty great at it over the long term. The Dow’s correlation with the S&P 500 was 0.93 over the past two years and was 0.99 over the past 10 years.
But for some unknown reason, a quirk of Dow changes has been that the performance of stocks that enter often get beat over the short term by those that leave.
It might seem inconceivable to some that Walgreens’ stock would outperform Amazon’s, which is one of the so-called Magnificent Seven group of tech stocks, but surely many thought the same when Apple Inc.’s
AAPL,
stock replaced AT&T Inc.’s
T,
In the year before Apple entered the Dow on March 19, 2015, the technology giant’s stock soared 71%, while telecom stalwart AT&T’s stock gained just 3.4%.
One year after the stocks were swapped, Apple’s had dropped by about 18% and AT&T’s had run up 16%.
Don’t miss: Buffett saved $460 million by waiting to swap AT&T for Apple
Meanwhile, over the past year, Amazon’s stock soared about 83%, while Walgreens shares plunged 40%.
Also read: R.I.P. the ‘Magnificent Seven,’ says analyst who coined the big-tech moniker. Here’s why.
Here’s how the stocks that entered the Dow and the stocks they replaced performed in the year after the last changes were made, on Aug. 31, 2020:
-
Salesforce Inc.’s stock
CRM,
-0.29%
fell 2.2% in the year after it entered the Dow, while the stock it replaced, Exxon Mobil Corp.’s
XOM,
-0.88% ,
soared 34%. -
Shares of Amgen Inc.
AMGN,
+1.40%
were down 11% a year after going in, while Pfizer Inc. shares
PFE,
+0.76%
were up 28% a year after getting booted. -
The jinx didn’t always hold, however, as Honeywell International Inc. shares
HON,
-0.09%
rose 38% in the year after entering the Dow, while RTX Corp.’s stock
RTX,
+0.54%
climbed 36% in the year after exiting.
This story originally appeared on Marketwatch
