By Derek Moore
Source: Dow Jones Weighting August 25th, 2020 IndexArb
Since the 1920’s Exxon Mobile has been a part of the Dow Jones Index. Soon their run will end as the index this week announced a few changes. This will shake up the weighting in the index. A larger impact will come once Apple’s 4-1 stock split takes place.
Above we can see where the index was Wednesday and the top 5 stocks by weight. As a reminder, the higher the weight of a stock, the more its price changes impact the index. Most indexes are market cap weighted which means that when you take the number of shares by the stock price. So, the largest stocks which have the most weight like in the S&P 500 Index, affect the index the most.
Apple’s Weight Will Go Down in Dow Jones Index Post Split
With the Dow Jones, it is a price weighted index. So, the higher the price, regardless of market cap, the greater the weighing. This means that theoretically a stock with a tiny market cap, but a very high price could be weighted the highest. This is significant since Apple post-split will wind up with somewhere between a 3% and 4% weighting compared to the current 12%. In the S&P 500 Index, this split will have zero effect on that market cap weighted index since the number of shares will go up by 4 times while the price will be 1/4th.
Additions and Subtractions Dow Jones Index
CNBC reported yesterday that Salesforce, Amgen, and Honeywell will be added to the Dow while Exxon Mobil, Pfizer, and Raytheon Technologies will be removed. Salesforce based on their current price would land just ahead of Goldman Sachs on a weighted basis who currently sits at #6. Because the Dow Jones is only 30 stocks, additions and subtractions matter a little more. Especially given the price weighting we previously referenced.
Why We Do Not Generally Use Dow Jones based ETFs for Strategies
For most of our long-hedged equity strategies our underlying index of choice is the S&P 500 Index. It is a better representation of a broad market weighted index for US Large Cap. It also does not have as great of a chance for additions and subtractions and stock splits to have material effects. We are not alone though. Bob Pisani, on CNBC during a segment today, used a graphic explaining that only $31 Billion of investments are linked to the Dow Jones Industrials compared to $11.2 Trillion linked to the S&P 500 Index.
It looks like the date for these changes is August 31st which happens to be the ex-date for the Apple split. Keep an eye on how the Dow moves going forward relative to Apple and the S&P 500.