Memorandum: Dow Jones Industrial Average – July 2017
Northwest companies Microsoft, Boeing and Nike are all members of the Dow Jones Industrial Average (Dow, DJIA). Another Northwest company, Amazon, has become one of the largest in the world. Will Amazon also be added to the Dow index?
This is a good question and the short answer is extremely doubtful. Why? To answer that we need to look a bit at the history of the Dow Jones Industrial Average and how the Index calculates its value.
In 1882, Charles Dow, Edward Jones and Charles Bergstresser founded Dow Jones & Company (Thank goodness Bergstresser did not get his name in the company title). However, the Dow Jones Industrial Average was not created until four years later and was launched on May 26, 1896. The original companies in the Dow were as follows:
- American Cotton Oil
- American Sugar
- American Tobacco
- Chicago Gas
- Distilling and Cattle Feeding
- General Electric
- Laclede Gas
- National Lead
- North American
- Tennessee Coal and Iron
- US Leather, Preferred
- US Rubber
Of these companies only General Electric still exists. Then in 1929, the Dow was expanded to 30 companies and that is the same number of stocks in the Index today. Fundamentally, the individual stocks that make up the average are intended to reflect the larger picture of the US economy. Back in 1896, commodities were the drivers of the economy, while the current make up is much more diverse. Here are the current companies as of July 19, 2017 that make up the Dow Jones Industrial Average:
Johnson & Johnson
Procter & Gamble
As you can see a much broader group of stocks than the original list representing the diverse American economy of today.
But to answer the first question, why is Amazon (one of the largest companies in the US) not included in the Dow?
The answer lies in how the movement of the Dow is calculated. This is what is referred to as a price weighted Index. Meaning the price of the individual stocks within the Index make up the total value and the daily price movement of these stocks affect the Dow. Look at it his way. When in 1896 the Dow was first created the Index was valued by adding up the price of each of the stocks contained in the Index and dividing by 12 and resulted in the first published Dow Jones Industrial Average of 40.96. Over the years companies and left the Dow, stocks have split and a Dow Jones Industrial Average Divisor was created to take all of that in to account. Without getting in to the details take it for granted that the Divisor works. So the result of this type of price weighed average the movement of $1 in any of the Dow stocks has the same impact on the Average without regard to the actual size of the company. Using the current Divisor a $1 move in the price of any Dow stock will change the Dow Index by roughly 7 points.
So let’s use an example of just 2 Dow stocks, IBM and Microsoft. As of July 19, 2017 the share price of IBM was $147.39 and Microsoft stood at $73.86. A $1 move in IBM is .6% of the stock price but a $1 move in Microsoft is 1.3%. Yet when either stock moves $1 it has the same effect of moving the Dow, up or down, by 7 points. Look at it this way. If these were the only 2 stocks in the Dow and Microsoft moved up $1 IBM moved down $1 there would be no change in the Dow. Yet in looking at the actual stocks Microsoft was up 1.3% and IBM was down .6%. If my account only held those 2 stocks at the end of that day I would be up .7% (1.3%-.6%=.7%) but the Dow would report no change. A bit confusing but this does illustrate the Price Weighed method. This has worked for the Dow for many over 100 years and I do not see any change soon.
Again the question is why is Amazon not included in the Dow? Because Amazon sells (as of July 19, 2017) for $1,026.87 per share. A $1 dollar move in Amazon is only .09% of Amazon’s price. A $10 move is not even 1%. If Amazon was in the Dow a $10 per share move in its price would impact the Dow by 70 points. To give an idea on the potential impact of adding Amazon to the Dow we looked back 12 months to see examine the daily swing in the Amazon stock price. On November 10, 2016 Amazon rose $36.43 per share and that one stock alone would have moved the Dow up 255 points. Conversely on May 1, 2017 Amazon stock fell -20.43 and that alone would have moved the Dow down 143 points. As you can see this one stock would have a tremendous effect on the Dow Average. So without a significant stock split the probability of Amazon ever being added to the Dow Jones Average is very slim.
In another memo we will review the Standard & Poors 500 Index and how the market weighted approach of that Index makes it results so very different.
Disclosure: Dow Jones Industrial Average – The Dow Jones Industrial Average is a popular indicator of the stock market based on the average closing prices of 30 active U.S. stocks representative of the overall economy. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results.