W e hear all the time from reporters and news anchors how the market has performed. But what exactly do we consider the “market”? There are many options but when it comes to the granddaddy of all market indexes, we need to refer to the Dow Jones Industrial Average or DJIA for short. Created in 1896 by Charles Dow and Edward Jones (no relation to the founder of Edward Jones Investments), the index was originally composed of only a dozen stocks, all of which were industrial companies.
Fast forward through the years and the evolution of the index has been methodical. Today, the index is made up of 30 blue chip companies, and represents industries ranging from financial services and healthcare to technology and telecommunications. The committee that manages the DJIA intentionally makes infrequent changes with the goal of providing continuity over time. Since 1896 the stocks within the index have only changed on 60 different occasions – just once every two years, on average.
On August 31st the committee removed three companies: Exxon Mobil, Pfizer and Raytheon Technologies. Exxon joined the Dow Jones Industrial Average in 1928 and was the industrial average’s longest-lasting component. Chevron now remains as the only energy company in the index. The three new companies being introduced are: Customer relationship management specialist Salesforce; Biotech firm Amgen; and industrial conglomerate Honeywell.
The change was the first major one since 2013 and caused by the recent Apple 4-for-1 stock split. Given that the index is price-weighted – – meaning higher priced stocks have greater impact on the index – – the stock split resulted in a large reduction to the index’s tech-sector weighting.
“The announced changes help offset that reduction,” S&P Dow Jones said in a statement. “They also help diversify the index by removing overlap between companies of similar scope and adding new types of businesses that better reflect the American economy.”
After all the moving around, Apple’s position in the index will change. Previously in the No. 1 position in the price-weighted index, Apple will slide to No. 17 due to the split. Taking over the top three spots will be UnitedHealth Group, Home Depot and Amgen, in that order.
There is a certain cachet to being included as one of the 30 companies in the average. It shows a level of size and dominance, but does it lead to better stock performance after being adopted by the committee? Given there are so few changes to the index historically, it is not a large sample size to analyze. But data over the past 20 years does show that those stocks added to the index perform relatively worse than compared to those booted from the index.
Over the past decade the stocks added to the Dow have essentially been flat, while those stocks removed rose 10%. If we look back even further, since 1999, stocks added have declined 10% as a cohort, while those bumped saw a less-severe 2% drop.
A contrarian may see opportunity in Exxon, Pfizer or Raytheon. Especially with the recent boom in index investing, companies are being bought, in many instances, solely on their inclusion in the Dow. Recent history has rewarded those willing to move against this flow of traffic. There are a lot of elements at play here, but as Mark Twain said, “History doesn’t repeat itself, but it often rhymes.”
