Dismantle the Decrepit Dow

The Dow Jones industrial average continues to be synonymous with the stock market—its daily move will often kick off the nightly news—even though it has never been less representative of the real-time American economy.

Last week, Google, one of the most disruptive players in the history of technology—ask any media company, particularly Dow component Microsoft—for the first time crossed $1,000 a share to become the third most valuable company in the U.S., after ExxonMobil and Apple. Of those three domestic market-value leaders, only Exxon is in the Dow.

What is the most influential component in the blue-chip index? Try new inductee Visa. No. 2? Wobbly centenarian IBM. The Dow’s methodology—weighting the index on stock price (by itself is a meaningless number, rather than market value)—results in inconsistencies such as Chevron moving the needle more than Exxon, which has more than twice Chevron’s yearly revenue. Simply by dint of its higher stock price, newby Nike throws around more sway in these parts than JPMorgan Chase, the biggest too-big-to-fail bank. Hey, has anyone seen my abacus?

Investor sentimentalists, inspect this chart and weep: Had the keepers of the Dow displayed the foresight and open-mindedness to add Google and Apple in recent years, the index would be at a far higher record today. Instead, they incorporated the backward-looking, performance-draining likes of Cisco Systems, American International Group, and Bank of America (the last two were booted after they tanked), and let smokestacker Alcoa stick around until just a few months ago. Ditto tech old-guardsman Hewlett-Packard. And what of there currently being no automaker in the Dow since bankruptcy-bound General Motors was excommunicated in 2009? The industry has come back with a vengeance.

“The bottom line is that the Dow no longer reflects the pulse of the globe,” says Brian Sozzi, head of equity research shop Belus Capital Advisors. “Of course, it contains transports. But the products being used by the Dow, watching Main Street and corporate America day in and day out—tech—are not properly represented. Think about how more Apple tablets are helping to drive non-farm productivity and child education.”

There is no way the Dow can add split-resistant influencers such as Google and Apple without violently crowding out the remaining 28 members. And by sticking to their methodology, the index-keepers are preventing themselves from including Amazon ($336 a share), the biggest thing to hit retail since Wal-Mart’s cut-rate 1990s march to the heartland.

Dave Guarino, a spokesman for S&P Dow Jones Indices, does concede that the question of including Apple and Google is on the minds of the index-keeping committee. “We consider it and we review the methodology often to make sure the Dow provides a representative snapshot of large-cap U.S. performance,” he says. “Right now, however, we have no plans to change how we calculate the index.”

They haven’t changed that formula in 85 years. Roaring 1928 was when the Dow expanded to 30 components, from 20, after making its debut in 1896 with 12 members, including American Cotton Oil Company and National Lead.

Back to the here and now. Would it kill the Dow’s handlers to expand to, say, 40 components and espouse a less-rigid methodology? They might well do so when they get their first smartphones.

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