Advice & Research
Jack Kraft, Market Advice Associate
Angela Shin, Market Advice Associate
On August 24, 2020, Standard & Poor’s Dow Jones Indices announced it would reconfigure the underlying components of the Dow Jones Industrial Average benchmark index for the first time since 2018. Effective August 31st, 2020, Salesforce.com, Amgen, and Honeywell International will replace Exxon Mobil, Pfizer, and Raytheon Technologies in the price-weighted index that tracks 30 industry leading blue-chip stocks. The shake-up is intended to “diversify the index by removing overlap between companies of similar scope.”
The changes to the Dow were prompted by a 4-for-1 stock split in shares of Apple. It is important to understand how a price-weighted index is calculated in order to interpret the effects of a stock split on the benchmark index. The value is a simple average, taking a single company’s price per share and dividing it by the sum of all share prices in the index. Therefore, the lower share price resulting from a stock split reduces the weight of that particular security in the underlying index. The overall value of the index remains unchanged (due to adjustments in the Dow’s scaling factor) but a stock split can dramatically change the proportional weighting of its components.
Apple shares currently represent 12.2% of the Dow’s value, making the iPhone maker the single largest component. After the split, Apple will drop to the 17th most influential member with a new weighting of roughly 3.0%. UnitedHealth Group will take over the top spot after the reshuffling, followed by Home Depot.
As a result of the changes listed above, the Technology sector’s weighting in the Dow will fall from 27.7% to 23.1%, though it will continue to hold the largest weighting of any sector in the index. Meanwhile, the Energy sector’s relative importance to the benchmark will wane further, falling from 3.1% to 2.1% with the removal of Exxon Mobil, which had been in the index since 1928. On the other side of the equation, the Health Care and Industrials sectors will see an increase in weighting by 4.4% and 2.1%, respectively.
Modifications to the underlying constituents of the Dow are not uncommon and can be triggered by a multitude of market events, including mergers and acquisitions, poor performance, and stock-splits. However, multi-component swaps are infrequent. In fact, the last time the Dow replaced three individual companies was seven years ago when Goldman Sachs, Nike, and Visa replaced Alcoa, Bank of America, and Hewlett-Packard. Index composition changes can sometimes cause short-term price fluctuations in stocks that are added to or removed from key indices, particularly the S&P 500. In theory, demand for a security can increase following the inclusion of a stock to an index. This is attributed to the buying and selling of index funds that track a particular benchmark, and is referred to as “the index effect.” Over the long-term, however, there is no historical or empirical evidence of material impact on share price performance.
The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.
The S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.
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