The Dow's Amazon-Walmart-Walgreens shakeup is a reminder why it's no longer the benchmark
If you’ve ever wanted an example of how creaky and cumbersome the ancient Dow Jones Industrial Average (^DJI) has become compared with modern market metrics, take a look at this week’s Dow triple play involving Walmart (WMT), Walgreens (WBA), and Amazon (AMZN).
On Monday, the Dow replaced Walgreens with Amazon in reaction to Walmart splitting its stock 3-for-1.
That split, for reasons we’ll get to in a bit, reduced Walmart’s weight in the average — yes, the Dow is an average, not an index — by two-thirds.
Adding Amazon to the Dow, the folks at S&P Dow Jones Indices say, was done to keep retail companies’ weight in the average from falling sharply because of Walmart’s stock split.
Because the Dow has only 30 stocks, adding Amazon meant one of the other components had to go. So Walgreens Boots Alliance, which had the lowest weight in the Dow, got the boot and lost its alliance.
Walgreens being booted from the Dow isn’t exactly a surprise because its share price has fallen around 60% since being added to the average in June 2018, while the Dow has risen about 60%.
Had Walgreens kept pace with the other 29 components, the Dow would be about 400 points higher than it is. With the Dow near 40,000, it’s easy to see what little impact even an at-pace Walgreens would have made.
Amazon, by contrast, has been a hot stock, one of the so-called "Magnificent Seven" that accounted for the bulk of the stock market’s gains last year.
Walgreens’ Dow tenure lasted less than six years — an extraordinarily short time for a market metric that doesn’t change its component stocks very often.
But its exit, S&P Dow Jones Indices senior analyst Howard Silverblatt insisted to me, isn’t because Walgreens has slumped and Amazon has soared.
“We think it’s a better fit,” Silverblatt said. “We’re not saying it’s a better investment.”
Or, as Silverblatt put it on Yahoo Finance Live, Amazon will help the Dow stay “relevant.”
Now, a key question: will being added to the Dow be good for Amazon’s stock price?
My answer, which may surprise you, is no. Based on conversations I’ve had with market mavens over the years, I don’t think that being added to the Dow will make the slightest difference for Amazon shareholders. Just as Walgreens being kicked out won’t make any difference to Walgreens shareholders.
How can I say that when the Dow is such a popular market metric?
It’s because although the Dow has great mindshare, it has almost no financial market share compared with the hugely influential S&P 500 Index (^GSPC).
Let me explain.
The Dow is calculated based on the share prices of its 30 components. That’s why today’s three-for-one split, which reduced Walmart’s share price by two-thirds, reduced its weight in the Dow by two-thirds.
The S&P, on the other hand, measures companies by their total stock market value, not their nominal share price. That’s a much better way to reflect value than using share prices, which — as Walmart’s split shows — can fall substantially overnight even though nothing about the company has changed.
So the Dow needs to go through contortions to offset the impact of Walmart’s stock split while the S&P 500 does nothing. Walmart’s market capitalization is still around $472 billion, and that’s what counts.
The reason the Dow and the S&P are calculated so differently is age. The Dow was founded in 1896, when computers didn’t exist, and communication was glacial. Share prices were a quick and simple way to measure. The S&P 500, founded 61 years later, is a product of and for modern markets.
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This difference in calculation methodology is why a whopping $5.75 trillion of investor money is indexed to the S&P, according to Howard Silverblatt, but only $87 billion — a minuscule 1.5% as much — is indexed to the Dow.
Being added to the S&P has a big impact on a company’s share price because so much index money flows into it. And being dropped from the S&P hurts because all that index money flows out.
However, so little money (relatively speaking) is indexed to the Dow that being added to it or dropped out of it has no impact, hence why being added to the Dow won’t make any difference to Amazon’s share price.
One more impact of the Walgreens-Walmart-Amazon triple play: Through Friday, each dollar change in any Dow component moved the average by about 6.59 points. Monday’s number is different.
That’s because at Monday’s opening, the total share price of the 30 Dow components is different from the number at Friday’s close.
So the Dowfolk had to tweak something called the Dow Divisor, which as of Friday was a wonderfully precise 0.15172752595384 and is equally precise today. Divide one by the divisor, and you see how much each dollar change in any Dow component moves the Dow.
The history of how the Dow Divisor came to be and how to tweak it to create your very own Dow is a lot of fun for those of us who like numbers.
But that’s a subject for another day.
Allan Sloan is an award-winning financial journalist and contributor to Yahoo Finance.
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