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Geoff Gannon
Geoff Gannon

Dow approaches a new all-time high, How I see it

October 02, 2006 | About:

As the Dow approaches a new all-time high (the record close was 11,722.98), now would be a good time to take a break from the financial news found on your televisions, in your newspapers, (and yes) even on your computers.

A new high is an empty headline. I'm not writing to tell you that; you already know that. What you may not fully appreciate is just how arbitrary an index the Dow Jones Industrial Average really is.

Most notably, it's no longer very industrial. Only about one of every three stocks in the Dow is involved in what might be considered an old-line industrial (heavy manufacturing, extraction, etc.) business. A lot of the Dow components are involved in totally different businesses such as consumer products, health care, and technology. For the most part, these businesses are usually a lot less tangible. The businesses are asset-light; the future prospects are largely company specific.

Today, the extent to which the common stocks of the thirty companies move together may have more to do with their shared classification as "Dow" stocks than with the future prospects of the underlying businesses.

On April 8, 2004 some changes were made to the Dow. These weren't the first changes – and they won't be the last. Such changes add to the arbitrary nature of the index, especially in the short-term.

Generally, the changes have been motivated more by who should go than with who should come in. Discarded Dow components can usually blame a dying industry for their exit. Sometimes, a rapidly dwindling market cap helped.

The April 2004 changes involved three spots in the index and six stocks.

Departures: AT&T (T), Eastman Kodak (EK), and International Paper (IP).

Arrivals: Verizon (VZ), American International Group (AIG), and Pfizer (PFE).

Please note that AT&T is now back in the Dow. In November 2005, SBC Communications,which was itself born from the 1984 divestiture agreement between AT&T and the Justice Department, changed its name to AT&T after acquiring that company. It also adopted the ticker symbol associated with that name (T). As a result, a chart of the new AT&T does not reflect the fortunes of the old AT&T.

None of these stocks has fared particularly well. In fact, since the changes, they've all basically underperformed the S&P 500. With the exception of Kodak (and Verizon for a very short time), none of the stocks have managed to trade above the share price they had at the time of the reshuffle

Is this just a coincidence?

As a rule, reshuffling an index through human intervention is likely to produce odd (and unexpected) coincidences.

The Dow is made up of a small number of companies. These companies tend to be very high-profile businesses. They are also high-profile stocks. Usually, they were high-profile stocks before they entered; but, obviously, being added to the Dow only increases investor interest in their fortunes. Any human intervention is likely to reflect the (current) biases of investors (and the financial media).

The result? A very human index.

About the author:

Geoff Gannon
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 3.0/5 (3 votes)


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