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The Dow Jones Industrial Average that opened this morning is not the same one that closed on Friday afternoon.
Three stocks out of the 30 that make up the index were swapped out for fresh blood.
Changing three DJIA stocks at once happens more frequently than you may think. Since 1991, the Dow Jones has swapped out three components at once on three occasions, and on three other occasions, it swapped out four components at once.
The last time it happened was September 2013, when Goldman Sachs Group Inc. (NYSE: GS), Nike Inc. (NYSE: NKE), and Visa Inc. (NYSE: V) bumped out Alcoa Inc. (NYSE: AA), Bank of America Corp. (NYSE: BAC), and Hewlett-Packard Co. (NYSE: HPQ).
According to Dow Jones, the Apple Inc. (NASDAQ: AAPL) 4-to-1 stock split prompted the move. Today is the ex date for the AAPL split.
Dow Jones said the Apple stock split would have reduced the index's weight in the technology sector. Today's three-way switch will "help offset that reduction," it said.
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The move also helps "diversify the index by removing overlap between companies of similar scope and adding new types of businesses that better reflect the American economy," Dow Jones said.
That means less emphasis on fossil fuel energy (Exxon) and more on technology (Salesforce.com).
Because the 124-year-old Dow Jones Industrial Average has long been viewed by the general public and the media as the primary benchmark for stocks, it's important to understand how this change will affect the index.
How the Dow Jones Works
Let's first talk about what won't happen.
One might assume that swapping out three stocks would change the point value of the index – but it won't.
That's because of something called the "Dow divisor." This number is designed to maintain consistent pricing whenever a change occurs to the makeup of the index. A new Dow divisor will ensure today's change will not affect the value of the DJIA.
Another oddity of the Dow Jones is that it is a price-weighted index. In other words, the higher the price of a component stock, the more it influences the daily movements of the Dow.
Such quirks are why most seasoned investors prefer to use the S&P 500 index as their go-to benchmark for the markets.
Just look at the situation with Apple.
Prior to today, Apple had a weight of 12% in the Dow Jones, with UnitedHealth Group Inc. (NYSE: UNH) second at 7.5%. Pfizer was last, with a weight of just 0.91%.
This is what prompted today's change. The Apple stock split, by reducing the share price by 75%, reduces Apple's influence in the Dow by a corresponding amount. The minders of the Dow Jones were concerned tech would not have sufficient weight in the index.
Their long-standing goal is to adjust the DJIA stocks as needed to make the index as accurate a measure of the overall U.S. economy as they can.
And these changes under the hood are designed to cause as little disruption as possible to the index itself.
But what about the stocks involved? Here again, what one might assume runs contrary to reality…
When Jilted DJIA Stocks Get Revenge
Logic suggests stocks dumped from the Dow Jones will lag behind, while those newly anointed will thrive.
In 2008, Pomona College did a study on the fate of DJIA stocks – both those that were dumped as well as those that were added. It looked at data spanning 1928 to 2005.
That study found that stocks removed from the Dow collectively gained 175% over the following five years. New additions gained a mere 65%. That's quite a difference.
It happened again in 2013 – though the margin was not quite as stark.
The three stocks that exited the Dow – Alcoa, Bank of America, and Hewlett-Packard – collectively gained 89% over the next five years. The three that joined – Goldman Sachs, Nike, and Visa – collectively gained just 62%.
The explanation for this phenomenon reflects rather poorly on the Dow Jones decision-makers. In short, they tend to chase returns. So new members are usually rising stars. And the stocks that get the chop are typically the worst performers in the index.
Sure enough, over the two years, today's new DJIA stocks are collectively up 37%. The three ousted stocks are collectively down 27%.
But this strategy ignores a trait common to long-term stock performance, the Pomona College study pointed out.
"Regression to the mean suggests that companies taken out of the Dow may not be as bad as their current predicament indicates and the companies that replace them may not be as terrific as their current record suggests," the researchers said.
Of course, there are always exceptions to the rule.
Apple's tenure in the Dow Jones hit the five-year mark this past March. It was up 92% on the anniversary date. The stock it replaced, AT&T Inc. (NYSE: T), was down 6%.
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About the Author
David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.