Standard & Poors Changes the Dow Jones Industrial Average

Most of you will have heard of the Dow Jones Index and today marks one of the most important changes to this index with wide-ranging implications.

Standard and Poors are the company responsible for maintaining and calculating the Dow Jones Industrial Index. This index consists of 30 stocks that Standard and Poors considers are reflective of the American economy.

The index consists of names like Walt Disney, IBM, Visa, Coca-Cola, and JP Morgan Chase. But it is the strange way they weight the index that makes it different. Most indexes are market-cap weighted

Market Capitalisation is calculated by taking the last traded price of a share and multiplying it by the number of shares on issue. They then weight an index based on this calculation, so companies with the highest market capitalisation get a bigger weighting in the index.

This can be seen in the S&P500 where the top 5 names, Microsoft, Apple, Amazon, Facebook and Google, make up more than 20% of the index and explains why that index performance has been so strong this year.

But calculations for the Dow Jones Industrials are a little different. This index is weighted based on actual share price.

For example, presently Apple at $500 per share gets the largest weighting, followed by United Health at $300 per share. But this is going to change significantly as Apple has undergone a 4-for-1 stock split and therefore will trade around the $125 mark on Monday. That will change its weighting in the index significantly

Then, after the close, there will be another change.

Three companies are being kicked out of the index – Raytheon, Exxon Mobil and Pfizer. In their place, the following 3 will be added – Amgen, Salesforce and Honeywell

All these changes will change the weighting of every company in the index.

These changes will be significant due to all the index-tracking ETFs. An ETF that tracks the index does so by holding the shares in the index in the same weightings as they are found in the index. So, once these changes come into effect, ETF issuers must adjust their holdings in these shares accordingly.

You would expect to see some selling of Apple holdings and buying of Amgen and Salesforce.

Interestingly, longer-term, it makes little difference whether a share has been added to, or kicked out from an index. But we might get some short-term volatility in these names as traders adjust to the new weightings.