On 26 June 2018 Walgreens Boots Alliance replaced General Electric in the Dow Jones Industrial Average. What the index is, how S&P Dow Jones Indices decides and why the change does not alter its level.
S&P Dow Jones Indices announced on 19 June 2018 that Walgreens Boots Alliance would replace General Electric in the Dow Jones Industrial Average, Wall Street’s benchmark index known as the Dow. The change took effect before the open on Tuesday 26 June. According to the US financial press, General Electric was the last member of the original 1896 group still in the index. The committee recalled that GE was an original member of the Dow in 1896 and had been a continuous member since 1907.
What the Dow is and who decides
The Dow Jones Industrial Average was born in 1896, twelve years after Charles Dow created the first stock index. Today it brings together 30 large US companies and is calculated as a price-weighted index: each stock counts according to its share price, not the size of the company. That is why a huge company with a cheap share has very little influence on the result.
Which companies make it up is decided by the index committee at S&P Dow Jones Indices, chaired by David Blitzer. The committee announces changes a few days ahead: in this case, seven, from 19 to 26 June.
The reasons and the effect on the index
The S&P Dow Jones Indices statement gives two reasons. The first is technical: the low price of GE’s shares, which closed at $12.95 on 19 June according to the AP news agency, gave it a weight of less than 0.5% in the index, whereas Walgreens trades higher and will contribute more meaningfully. The second is more fundamental: in Blitzer’s words, the US economy has changed, and consumer, finance, health care and technology companies now carry more weight, and industrial companies less.
Walgreens Boots Alliance, headquartered in Deerfield, Illinois, is a pharmacy chain offering prescription and non-prescription drugs, health services and general goods. With its addition, according to the statement, the Dow will be more representative of the consumer and health care sectors. In after-hours trading on 19 June, according to AP, Walgreens shares were up 3.2% and GE shares were down 1.4%.
The change does not alter the level of the index. S&P Dow Jones Indices explained that the divisor used to calculate the Dow would be changed before the open on 26 June, so that the substitution does not distort what the index measures. GE’s exit and Walgreens’ entry do not move the Dow up or down by themselves; what changes is its composition.
What to bear in mind
The Dow is one of the most quoted indices, but also one of the most concentrated: only 30 companies, weighted by price. It is worth knowing which index each fund or product linked to the Dow tracks, how it weights its components and that such products adjust when the index changes composition. An index is a benchmark, not the whole market.
According to the statement itself, adding or removing a company from an index is not a judgement on the company: it is a decision about how to measure the economy and the market better.
GE’s exit, after being in the Dow continuously since 1907, shows that an index changes with the economy it represents.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
