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The Future of the Dow Industrials: Potential Changes and Vulnerable Components

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Introduction

Walgreens: A Troubled Addition

Walgreens, a prominent component of the Dow Industrials, is currently facing immense challenges. Since joining the index in June 2018, the company’s stock has plunged by approximately 65%. This significant decline has raised concerns among investors and analysts, leading to predictions of its removal from the index.

Recently, Walgreens made headlines again when it announced a substantial dividend cut of 48%, from 50 cents to 25 cents per quarter. This decision, although expected by many, caused further distress to shares, resulting in a 6.8% drop to $23.84 on Thursday.

Potential Changes and Candidates for Inclusion

If changes are made to the Dow Industrials this year, several potential candidates loom as possible additions. Google parent company Alphabet and e-commerce giant Amazon.com stand out as strong contenders due to their size and influence within the market. Additionally, renowned companies such as Berkshire Hathaway and Tesla have also been suggested as potential newcomers to the index. The last alteration to the index’s components occurred over three years ago, making this an opportune moment for potential adjustments.

Vulnerable Components for Removal

Apart from Walgreens, several other components face the risk of removal from the index. Travelers, Verizon Communications, and Intel are among the vulnerable contenders. Travelers bears resemblance to Walgreens, as its market value is also low in comparison to other constituents. Furthermore, the insurance industry lacks the same significance in the stock market as other sectors, further increasing the likelihood of Travelers’ exclusion.

Factors Influencing Index Decisions

When considering potential adjustments, S&P Dow Jones Indices takes various factors into account. Stock price becomes a crucial consideration, as the index’s components are weighted based on it, rather than market value, as practiced in other major equity indexes, including the S&P 500. Therefore, a company’s stock price and market value play pivotal roles when determining its eligibility and vulnerability within the Dow Industrials.

In conclusion, the potential reshaping of the Dow Industrials presents an opportunity for change and adaptation. Walgreens, due to its underperformance and dwindling market capitalization, faces significant vulnerability. Nonetheless, other prominent companies like Google parent Alphabet, Amazon.com, Berkshire Hathaway, and Tesla have emerged as potential candidates for inclusion. Meanwhile, Travelers, Verizon Communications, and Intel are deemed precarious components that might be exposed to removal. As S&P Dow Jones Indices considers adjustments, the weight of stock price as a determining factor remains paramount in shaping the future composition of the index.

The Price Weighting of the Dow Jones Industrial Average

The Dow Jones Industrial Average (DJIA) has a unique method of calculating its value, known as price weighting. This approach has been in place since 1896, long before the advent of the computer era. By using price weighting, the DJIA can provide a relatively simple calculation of its overall value.

To calculate the value of the index, the prices of the 30 components are summed and then multiplied by the inverse of the divisor. Currently, the DJIA is valued at around 37,500.

This price weighting structure has implications for the composition of the DJIA. Stocks with higher prices have a greater influence on the index compared to those with lower prices. For example, UnitedHealth Group, with a trading price of approximately $546, has more than 20 times the weighting of Walgreens. Therefore, changes in the stock price of UnitedHealth Group will have a more significant impact on the DJIA than changes in the stock price of Walgreens.

It’s worth noting that price weighting also means that companies with low stock prices may have minimal influence on the index. Despite Intel’s impressive 90% growth last year, its low stock price limited its impact on the DJIA.

The last change in the composition of the DJIA occurred over three years ago in August 2020. Salesforce.com, Honeywell, and Amgen were added, while Exxon Mobil, Raytheon Technologies (now RTX), and Pfizer were dropped. Prior to that, in June 2018, Walgreens was added and General Electric was removed. In March 2015, Apple was added and AT&T was removed.

Interestingly, we are currently experiencing the longest period without any changes to the DJIA components since 2015.

While Alphabet and Amazon are significant companies in terms of market capitalization (ranking third and fourth behind Apple and Microsoft, respectively), their stock prices around $140 allow them to have an impact on the index. On the other hand, Intel and Verizon, with their lower stock prices (trading around $47 and $39, respectively), have a limited effect on the DJIA. However, Travelers, even with a smaller market value, still has a notable impact on the index due to its higher share price of $195.

In conclusion, the price weighting of the DJIA enables a straightforward calculation of its value but also results in different stocks having varying degrees of influence on the index. As we await the next change in its components, it becomes evident that certain companies wield more power in shaping the DJIA than others.

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