Dow Jones dumps GM and Citi..

[UltraVires]

http://news.yahoo.com/s/ap/20090601/ap_on_bi_ge/us_dow_components

I wondered if this would affect the DJIA, but this snippet says no:

@the article

The changes to the Dow likely won’t affect many investors because the index is weighted by price. Therefore, the low share value of Citi and GM mean they have held less sway in recent months. And Dow will adjust the formula by which the index is calculated so the addition of Travelers and Cisco won’t affect the value of the average.

My question is: What good is the DJIA if it is simply changed at the whim of the market? If it is the same whether GM or Cisco is in there, then what meaning does it have?

[Exapno_Mapcase]

The truth is that serious investors pay no attention to the DJIA. They look at broader indexes like the S&P 500 or the Wilshire 5000.

The Dow is more of a promotional tool for the industry than anything else. It’s a brand name that unsophisticated investors can follow and see the broad trend of whether the market is going up or down. It is emphasized when the market goes up and hardly talked about when it goes down.

A company in bankruptcy has to be eliminated since the stock no longer has value and is therefore useless for trend analysis. The real gaming of the system is done when a company which is merely doing badly gets replaced by a company that’s doing well.

Ignore the Dow. Ignore anyone who tells you to pay attention to the Dow.

[RealityChuck]

The stocks in the DJIA always change over time. The only stock that has remained a part of it from the beginning was GE. Here’s the list of the other original stocks:

@Wikipedia

* American Cotton Oil Company, distant ancestor of Bestfoods, now part of Unilever
* American Sugar Company, now Domino Foods, Inc.
* American Tobacco Company, broken up in 1911 antitrust action
* Chicago Gas Company, bought by Peoples Gas Light in 1897 (now an operating subsidiary of Integrys Energy Group)
* Distilling & Cattle Feeding Company, now Millennium Chemicals, a division of LyondellBasell
* Laclede Gas Light Company, still in operation as The Laclede Group, removed from the Dow Jones Industrial Average in 1899
* National Lead Company, now NL Industries, removed from the Dow Jones Industrial Average in 1916
* North American Company, (Edison) electric company broken up in the 1940s
* Tennessee Coal, Iron and Railroad Company in Birmingham, Alabama, bought by U.S. Steel in 1907
* U.S. Leather Company, dissolved 1952
* United States Rubber Company, changed its name to Uniroyal in 1961, merged private with B.F. Goodrich in 1986, bought by Michelin in 1990.

Stocks are added and removed from time to time. The DJIA stock prices are subject to a multiplier that makes it relatively comparable over time. This if one stock is at $5 and is replaced by a stock currently trading at $20, the multiplier is adjusted so the DJIA does not changed. One disadvantage of this (a major one), is the the multiplier exaggerates stock movement (which is one reason why experts use other indexes).

Thus if adding a new company were to increase the DJIA by 50 points (after the exchange is closed), the multiplier is adjusted so the DJIA remains the same.

[Simplicio]

@Exapno_Mapcase

The truth is that serious investors pay no attention to the DJIA. They look at broader indexes like the S&P 500 or the Wilshire 5000.

I don’t know about Wilshire, but S&P basically tracks the Dow with close to 100% fidelity. Here’s a graph of both indexes over the last five years, and I’ve seen ones that go back a few decades with the same about of correlation. I don’t think anyones getting any information out of one that they couldn’t get out of the other.

[Freddy_the_Pig]

The composition of any stock index must be adjusted from time to time as companies merge, go bankrupt, and/or decline in economic significance, and as new companies and industries emerge. This is an issue for the S&P 500 every bit as much as for the Dow.

[yabob]

Note the S&P 500 also has membership determined by a committee which decides what to include, and periodically changes the list. That method of operation does not preclude the usefulness of the index, if you think the committee is exercising good judgement. recent changes to the S&P 500:

Home | S&P Global Ratings

[yabob]

@Simplicio

I don’t know about Wilshire, but S&P basically tracks the Dow with close to 100% fidelity. Here’s a graph of both indexes over the last five years, and I’ve seen ones that go back a few decades with the same about of correlation. …

I was going to bring that up, but I’d put it the other way around - the Dow has tracked the more highly regarded S&P 500 very closely, in spite of the acknowledged drawbacks in the Dow.

[yabob]

@Freddy_the_Pig

The composition of any stock index must be adjusted from time to time as companies merge, go bankrupt, and/or decline in economic significance, and as new companies and industries emerge. This is an issue for the S&P 500 every bit as much as for the Dow.

But some, notably the Russell indexes, do so via mechanical rules rather than committee selection.

[Bill_Door]

The major effect will be when index funds sell off their GM and Citibank stock. They won’t have to do it all at once, but they’ll have to eventually.

[hajario]

@yabob

Note the S&P 500 also has membership determined by a committee which decides what to include, and periodically changes the list.

Within a set of rules. For example, any company that is selected must have a market capitalization of at least $4 billion.

[yabob]

And with CSCO, we once again have a non-dividend paying issue in the DJIA (I’m going to consider GM “dividend paying” - it’s just been suspended for a while). I wonder if they are going to start paying one like MSFT did a few years after entering the index.

[Captain_Amazing]

@Bill_Door

The major effect will be when index funds sell off their GM and Citibank stock. They won’t have to do it all at once, but they’ll have to eventually.

If GM is bankrupt, the index funds won’t have any GM stock, right? It will all have gone away from the bankruptcy.

[FORTRAN_forever]

@Exapno_Mapcase

The Dow is more of a promotional tool for the industry than anything else.

Well, actually it has one other advantage over its brethren indeces - it’s been around since 1884. The Standard and Poors index that eventually morphed into the S&P 500 wasn’t set up until 1923.

[Jackknifed_Juggernaut]

Another big weakness of the Dow is that it is price-weighted, while most indices are cap-weighted. This means that the actual price of a stock, which is an arbitrary number (based on the number of shares outstanding), affects it’s impact on the index.

[zagloba]

Is the S&P 500 cap weighted?

[yabob]

@zagloba

Is the S&P 500 cap weighted?

They’ve actually refined it a bit and made it float-weighted. From the wiki article:

The index has traditionally been market-value weighted; that is, movements in the prices of stocks with higher market capitalizations (the share price times the number of shares outstanding) have a greater effect on the index than companies with smaller market caps.

The index is now float weighted. That is, Standard & Poor’s now calculates the market caps relevant to the index using only the number of shares (called “float”) available for public trading. This transition was made in two steps, the first on March 18, 2005 and the second on September 16, 2005. (For example, only the Class A shares of Google (“GOOG”) are publicly traded; thus, of the 207,096,000 total shares outstanding as of March 2006, only the 199,570,000 Class A shares were considered float, so only the value of the latter number of shares was used to incorporate Google into the S&P 500 on March 31, 2006.) Only a minority of companies in the index have a float value that is lower than their total capitalization. For most companies in the index S&P considers all shares to be part of the public float and thus the capitalization used in the index calculation equals the market capitalization for those companies.

[CaveMike]

@Exapno_Mapcase

It is emphasized when the market goes up and hardly talked about when it goes down.

It is emphasized when it moves up or down. This was particularly obvious when the market was tanking last fall. Every financial show emphasizes the DJIA; many of them lead off with its daily movement.

[ivylass]

My mortgage is with Citi. I will keep paying my mortgage, but it will be interesting to see how this shakes out. Maybe they’ll sell it.

[Really_Not_All_That_Bright]

I’m surprised they haven’t already. According to the prospectus we got from them they sold 80% of the mortgages they originated in 2007, IIRC.

[Caldazar]

@jtgain

What good is the DJIA if it is simply changed at the whim of the market? If it is the same whether GM or Cisco is in there, then what meaning does it have?

The DJIA is supposed to be track the stock prices of large companies that are highly influential in the business world. In theory, it is supposed to indicate something about the state of big business in the US. Whether it actually achieves this goal is another matter.