A Change in the DJIA

Two stocks in the Dow Jones Industrial Average are going to be replaced:

Bank of America Corp. and Chevron Corp. will replace Altria Group, Inc., and Honeywell International, Inc., in the Dow Jones Industrial Average, effective with the opening of trading on February 19, Dow Jones & Company announced.

These changes are the first in the 111-year-old stock index since April 8, 2004, when three stocks out of 30 were replaced. [link]

The reasons are somewhat arbitrary, but they try to represent stock market leaders as accurately as possible.

“As usual when we make any change we review all the stocks,” Mr. Brauchli said. “In doing so, we saw that the financials industry was under-represented – notwithstanding the current turbulence – and that the oil and gas industry’s growing importance to the world economy called for another representative to join ExxonMobil Corp,” he said.

John A. Prestbo, editor of Dow Jones Indexes, said, “There are no pre-determined criteria for a stock to be added or deleted, though we intend that all components be established U.S. companies that are leaders in their industries.” For the sake of continuity, composition changes are intentionally rare, Mr. Prestbo said. [link]

The Dow is an equal-weighted index (where the value of the index is merely an average of all the stock prices in the index). But to maintain continuity in value – so that there are no drastic jumps or drops, and the index moves relatively smoothly – they alter the value of the denominator. They do this to offset the effects of stock splits (which traditionally halves the value of the stock) and other corporate actions.

Ordinarily, the denominator would be 30 (since there are thirty stocks in the index), but since they’ve changed the composition and the number of stocks in the index several times since its inception, the denominator is now 0.122834016. As the stock prices change, the value of the Index also changes. To calculate the value of the index at any given point in time, add up the stock prices of the components and divide by the denominator above.

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