Can we improve the Dow?
Filed under: Economy, Investing
There has long been criticism about how the Dow is calculated. While most indices are weighted by market capitalization, the Dow is weighted by price. This can skew things significantly (you can read more about that in Zac Bissonnette's post on the subject).There has also been much criticism of late that the Dow Jones Industrial Average index no longer provides an accurate snapshot of the overall U.S. economy.
But if not the Dow, then what? What would be a better approximator? Well, many would be content to look at the broader index, the S&P 500, but if we just wanted to keep it to 30 companies, the number of components currently in the Dow, one could use the top 30 companies in the S&P 500. Better yet, one can use the 30 companies with the highest market capitalization. Surely, there's a reason their market cap is high.
Calculating these 30 companies at Friday's close gives a simple average of 41.08, compared to the Dow's 30 companies simple average price of 30.83 -- that's 33% higher. If we apply the Dow's divisor instead of the simple average we get the Dow's close on Friday (30.83*30/0.125552709) of 7365.67. Applying the same divisor to the 30 companies with the highest market cap (which isn't right really, but for comparison purposes only) we get 9815.72. Wouldn't you like to have the Dow there now?
(One point to make is that Google and Berkshire Hathaway are not included so that they wouldn't affect the results too much.)
But do the highest market cap stocks really represent the economy better? Not necessarily.
Looking at fourth quarter GDP, we can find the weight of the different sectors. It's quite clear from the GDP that the Dow does not reflect the economy, nor do the top market capitalized stocks. For one thing, where are the housing companies? For another, even if we put Ford in the index, the car companies stocks wouldn't amount to their real weight in the economy.
The guardians of the Dow, The Wall Street Journal editors, try to keep to a minimum any changes in the component stocks. Striving then to keep as much of the original Dow as possible, I've replaced only five stocks. GM (GM) stayed, despite Ford (F) having a slighly higher market cap. Similarly, Intel (INTC) and Hewlett-Pakcard (HPQ) could have been replaced with the larger Cisco (CSCO) and Apple (AAPL), but weren't. Bank of America (BAC), Citigroup (C) and American Express (AXP), however got the boot, and Wells Fargo (WFC) took their place. Similarly, Alcoa (AA) was replaced with Freeport McMoran (FCX). Toll Brothers (TOL) and D.R. Horton (DHI), despite their small market cap, were added to better represent housing and construction and UPS (UPS) was added for transportation. Chevron (CVX) also got the boot since oil & gas was overweighted.
After all these changes, the simple price average was 30.82 compared to the original 31.36 -- a small change. With the divisor it was 7494.06, compared to 7365.67.
Perhaps the Dow needs changing to reflect the economy better, but it seems that this won't necessarily change things much. Investors, traders, may want to blame their losses on the index, but the fact is that the only thing that is to blame is the economy (and the plethora of reasons we're in recession today).
| DJIA | Top 30 market cap | Economy weighted |
| AA | AAPL | BA |
| AXP | ABT | CAT |
| BA | AMGN | DD |
| BAC | COP | DHI |
| C | CSCO | DIS |
| CAT | CVX | FCX |
| CVX | DNA | GE |
| DD | GE | GM |
| DIS | HPQ | HD |
| GE | IBM | HPQ |
| GM | INTC | IBM |
| HD | JNJ | INTC |
| HPQ | JPM | JNJ |
| IBM | KO | JPM |
| INTC | MCD | KFT |
| JNJ | MRK | KO |
| JPM | MSFT | MCD |
| KFT | ORCL | MMM |
| KO | PEP | MRK |
| MCD | PFE | MSFT |
| MMM | PG | PFE |
| MRK | PM | PG |
| MSFT | QCOM | T |
| PFE | SLB | TOL |
| PG | T | UPS |
| T | VZ | UTX |
| UTX | WFC | VZ |
| VZ | WMT | WFC |
| WMT | WYE | WMT |
| XOM | XOM | XOM |
| 30.83 | 41.08 | 31.36 |
| 7365.67 | 9815.72 | 7494.06 |
Why is Oprah going to cable? Hint: It's nothing to get teary about
Kisses from Hershey: Candymaker may court Cadbury with $17 billion bid
D-Day for Harry Reid: Can he wrangle 60 votes for Senate health reform bill?
Reader Comments (Page 1 of 1)
2-24-2009 @ 10:05AM
bypie6 said...
If you still cling to the hogwash about the Dow being an indicator of the present economic status ---- after seeing the connivings, corruptions, etc. of the past decades --- please send me an offer for the Brooklyn Bridge and expect a reply.
Just like W. Fields said years ago, "there's a sucker born every minute."
Reply
2-24-2009 @ 11:03AM
Sarah said...
Why is oil mutual fund, natural resources stock sinking so much when it was either high or going up now.....because THEY are taking their money from it, the investors money.....
2-24-2009 @ 12:29PM
lionshmglbn said...
Avalanche # 2....WHAT THE EUROPEAN ESTABLISHMENT IS FACING NOW.....The banking system of Europe is at the edge of the abyss. A brief story by The Telegraph revealed this last week. The original was almost immediately deleted. A new version was substituted. .....The original February 11 story was a shocker. The author claims to have seen a secret European Commission report. The report estimates that losses (write-downs) by European banks will be in the range of $25 trillion. ....If true, then to save the banking system, European governments will have to find an extra $25 trillion, fast. There is only one source of such funding: the central banks, mainly the European Central Bank (ECB). .....For comparison's sake, consider the $700 billion banking bailout in the United States last fall. Of this, only about half has been spent. That was sufficient bailing wire and chewing gum to keep the American banking system going. More will be needed, but so far, this has sufficed.
Reply
2-24-2009 @ 12:40PM
dang1067 said...
I shalll post this post repeatedly until all Wall Street mother-F*CKERS are cited plunging themselves from rooftops of tall buildings from every corners of the earth!!! Here it goes: "Every milliseconds I pray to the CURSING GOD to CURSE Wall Street to sink to NEGATIVE -1,000 points and to CURSE all oil Companies to sink their barrel oil-price down to half penny... And to causes all Wall Streeters PLUNGING from every rooftops of tall buildings.... I pray, I pray, I curse, I curse, and I curse for all Wall Street mother f*ckers be infected with horrible cancers and incurable diseases!!!! May their flesh be eaten slowly with maggots and have their bones rots very slowly!!!! I curse, I curse, and I curse to PLUNGE Wall Street to NEGATIVE -1,000 points, and to sink oil-price to worthless half penny!!!! Greed and Corruptions of Wall Street and all Oil Companies are the ones to blame for this economic Hell-Hole!!! CCURSSSE!!! PLUUUUNGE you Oil-Camels and Wall Street mother f*ckers!!!!!
Reply
2-24-2009 @ 12:53PM
lionshmglbn said...
NEWS NOT PUBLISHED IN THE MEDIA,...OR YEARS LATER IF AT ALL....Global Research publishes news and feature articles. The latter consist of opinion articles, analytical articles as well as detailed research reports on important topics. ,,Both news and feature articles are categorized by Geoographic Region , Major Theme and News Highlight . ,,,The Global Research collection of articles constitutes an invaluable source for the conduct of research on economic, political, social and environmental issues. ...Articles in our archive are categorized by author, and by country. An internal search by key word, as well as a Google search are also available. ..._Submissions___>Global Research welcomes submissions of news and opinion articles. Sources and references should be indicated where applicable with a view to ensuring a high degree of accuracy. Texts must be carefully edited prior to submission. Global Research has the discretion to edit articles and undertake minor modifications prior to pu
Reply
2-24-2009 @ 1:11PM
Zaphod said...
The dow is as reliable of an indicator as a racing form
Reply