New Changes To The Dow, Should You Care?
The Dynamic Wealth Report
June 8, 2009
New Changes To The Dow, Should You Care?
by Corey Williams, Editor
Today, two icons of American business are being removed from the Dow
Jones Industrial Average. Thanks for playing, General Motors (GM) and
Citigroup (C). Hello, Travelers (TRV) and
Cisco Systems (CSCO).
Once upon a time, GM and Citi were titans of their industries. They’ve
been reduced to wards of the state (or federal government). GM is now in
bankruptcy. Citi is holding on by a thread, thanks to the ‘too big to
fail’ policies and billions of dollars of bailout money.
The recession’s exposed the inept management and over leveraging (too
much debt) of these institutions. In a truly free market, these companies
would have been gone long ago.
Now that their day has finally arrived, what does this Dow shake up
mean?
Not much really. The Dow is largely irrelevant as an index.
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Let me explain. It’s impossible to gauge an entire stock market based on
30 stocks. To make matters worse, the Dow is price weighted, not market
cap weighted. That means companies with the highest stock prices have
the biggest impact on the Dow.
However, stock price isn’t everything. A higher stock price doesn’t mean
the company is bigger or better. Companies' stock prices will vary due to
how many shares they have issued. A better measure of a company’s impact
is its market cap.
Market cap (short for capitalization) measures the size of a company.
It’s easy to calculate. Simply multiply the number of shares outstanding
by the current price.
It stands to reason the larger the company, the bigger the impact on the
economy (and any index it’s part of).
For example, let’s look at the two new companies being added to the Dow
today. Travelers' stock price is $43.75 and Cisco’s is $19.87. Since
Travelers stock price is much higher than Cisco, the Dow’s price
weighting model gives more weight to Travelers.
Now let’s look at their market caps.
Travelers has a market cap of $25 billion. Cisco has a market cap $112
billion. Cisco is more than 4X bigger than Travelers. Yet, Travelers
will have a bigger impact on the Dow because its price is higher… it’s
no wonder the Dow’s no longer relevant.
However, there is still one area the Dow is useful.
That’s as a gauge of public sentiment. The Dow’s the most well known of
any index; it’s really an iconic measure of the markets. It dates back
to 1896.
Among people with little financial knowledge, the Dow is a widely known
gauge on the financial markets. The widespread use of the Dow in the
media keeps it relevant. Not for any practical application but for
gauging everyone else’s feelings on the market.
The next time you look to see what the market is doing, look to the S&P
500 and NASDAQ. They’re much better indicators of what’s transpiring.
You’ll be a smarter investor.
Which brings us back to the removal of the two failed companies. Even
though these companies will continue to operate, the markets are finally
able to voice their opinion. They’re saying, these companies are not
viable in a free market. And I agree whole heartedly.
Companies should be allowed to fail. It isn’t government’s job to save
them from themselves. At least the government can’t dictate which
companies are included in the Dow. The free market lives on… sort of.
• Pipeline Industry (Up 15%)
The recent rally in energy prices are also helping to push the value of
other energy assets higher, specifically pipelines. In the last month,
the pipeline industry has rallied more than 15%. Leading the group
higher is Atlas Pipeline (AHD).
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