The Dow Jones Industrial Average:
Is it a Fair Index of
Industry and Commerce?
By Bernard Levy
The Dow Jones Industrial Average
needs immediate revision. Why? It’s no longer a reasonable indicator of
Wall Street activity. Wall Street
lives, breathes and becomes healthy and ill on its daily movement, and its
current composition is sorely lacking.
First published in May, 1896,
only General Electric remains from the original index. From my reading of history, the DJIA
intended to represent the business pulse of our country. The first list included all of the
industrial companies listed on the New York Stock Exchange. Food, sugar, tobacco, utilities, chemicals,
rubber, coal, iron and manufacturing made the first list. Originally 12 companies, the list was
expanded to 30 in 1928.
There has been continuing
criticism of the Index due to its price-weighted average. This column was drafted prior to discovering
The Dow Jones Industrial Average: The Impact of Fixing Its Flaws by John
B. Shoven, Stanford University and NBER, and Clemens Sialm, Stanford
University, published June 29, 2000 as part of The Finance Program of The Stanford Institute for Economic Policy
Research. The paper discusses at
length the authors’ conclusion that “The DJIA Has Three Major Flaws,” the first
of which was that “Each company in the index is weighted by the price of its
stock.” I realized this flaw before I
read the article. This price-weighted
average gives indexed higher-priced stocks wrongfully more clout than lower-priced
ones.
For instance, during the
trading hours of May 30, 2006, the DJIA lost $184.18. However, the day’s losses of the 30 listed stocks totaled $23.01;
all of the listed stocks posted losses.
For an investor who purchased one share of each of the 30 stocks, his or
her loss would have only totaled $23.01.
However, to the world, it represented $184.18 total loss. This doesn’t make much sense, does it?
Messrs Shoven and Sialm,
after giving due credit to others who contributed to their studious work,
concluded there were two other major flaws in the index, namely the stocks, “are
chosen more or less arbitrarily by the Dow Jones & Co. to represent
different industries, but they are not chosen according to fixed or
well-defined rules,” and “the DJIA is not a total return index because it
excludes dividend distributions.”
Having covered the first
flaw, we now tackle the second flaw:
What then, would be a representative index , in this age of information
technology and our preoccupation with drug manufacturers, oil and energy? (We’ll leave the third flaw for others to
consider.)
Short-term investors,
brokerages and Wall Street analysts and stock seers live on short-term swings
and volatility to earn their keep and need an up-to-date number one index.
The critical questions to be
answered in listing relevant stocks are:
What businesses do we rely upon to fuel our economy, and how many
categories should be represented on the index?
According to many economic
prognosticators and gurus, our economy’s foundations are housing, information
technology and services, consumers, health and related industries, oil and
energy and defense. These, at least,
should be reasonably represented; are they?
The first group, housing, is
not included, although it could be tangentially represented by Home Depot. I’ve placed telecom services – AT&T and
Verizon, diversified computer systems – IBM and Hewlett Packard, semiconductor
– Intel, and application software – Microsoft, into the second group. I’ve lumped several categories into the all-
encompassing consumer products and services, namely Altria – tobacco and foods,
Coca-Cola – beverages, MacDonald’s – restaurants, Proctor and Gamble – consumer
goods, Wal-Mart Stores – discount/variety stores, and Walt Disney Co. – entertainment. My fourth category, health and drugs, only
has manufacturers represented, Johnson and Johnson, Merck and Pfizer. Exxon/Mobil solely represents oil and
energy.
My final category, defense,
has Boeing Co. singularly designated as aerospace/defense, although portions of
the four conglomerates listed -- 3M
Co., General Electric, Honeywell International and United Technologies -- should
be included in this category. Others
listed may also be considered.
The above 22 of the 30 stocks
represented leave one company representing aluminum, ALCOA (none representing
steel); one representing insurance, AIG; one representing chemicals, E.I. duPont;
one representing auto manufacturing, General Motors; three representing credit
services and money center banks, American Express, Citigroup, and JP Morgan;
and one representing farm and construction equipment, Caterpillar.
What’s missing? -- Agriculture, steel, possibly another
non-ferrous metal company, housing, airlines and specific health-care
providers. Are there any categories
that should have additional information on the list? Yes: energy, information
technology, aerospace/ defense, semiconductors, entertainment, restaurants and
perhaps autos.
Who we are, business-wise, as
a nation continually changes. Airlines,
as we know, are currently “in the toilet,” but they are an integral part of our
transportation system. American vehicle
manufacturing is in serious difficulty.
Residential and commercial construction has been a major component of
our apparent resurging economy.
Wal-Mart, representing all retailers, is unacceptable; at least Sears or
Federated should be included. What
about Apple and a major health provider?
It’s easy to criticize in
this age of systemic, epidemic misrepresentation in business and government, but
the DJIA is out of touch with market reality.
Investors should be given a relevant index to assess how our economy is
viewed through the eyes of the Street.
Business is a
combination of war and sport.
André Maurois