Sept. 16, 2013

Some quick background on the familiar Dow Jones Industrial Average (DJIA)- It is a stock market index, and one of several indices created by Wall Street Journal editor and Dow Jones & Company co-founder Charles Dow. The industrial average was first calculated on May 26, 1896. The averages are named after Dow and one of his business associates, statistician Edward Jones. It is an index that shows how 30 large publicly owned companies based in the United States have traded during a standard trading session in the stock market. It is the second oldest U.S. market index after the Dow Jones Transportation Average, which was also created by Dow.

The Industrial portion of the name is largely historical, as many of the modern 30 components have little or nothing to do with traditional heavy industry. The average is price-weighted, and to compensate for the effects of stock splits and other adjustments, it is currently a scaled average. The value of the Dow is not the actual average of the prices of its component stocks, but rather the sum of the component prices divided by a divisor, which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index.

With that as a backdrop, it’s interesting to note there will soon be a major shakeup to the Index.  Goldman Sachs Group Inc., Visa Inc. and Nike Inc. will be added after the close of trading on Friday, Sept. 20. The companies replace Bank of America Corp., Hewlett-Packard Co. and Alcoa Inc., with the changes effective at the opening of trading on Monday, Sept. 23.

It marks the first “three for three” change to the index since Apr. 8, 2004. The last change to the index was the addition of Travelers Cos. Inc. and Cisco Systems Inc. on June 8, 2009.

The index changes were prompted by the low stock price of the three companies slated for removal and the Index Committee’s desire to diversify the sector and industry group representation of the index.

If anyone else is scratching their heads on why the DJIA can be at all-time historical highs yet virtually every company that started in the index is no longer in business, it is easily explained with the reshuffling and “gerrymandering” of the index by regularly replacing the worst performers with much stronger companies.