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Investment

Here's why Google and Amazon probably will never be included in the Dow

Google-parent Alphabet and online shopping titan Amazon probably will never be members of the Dow Jones industrial average, even though the two companies represent what has become the most dominant sector of the U.S. economy.

Questions arose Wednesday about the Dow’s composition, a day after the index’s managers said they were pulling General Electric and adding Walgreens Boots Alliance.

Josh Brown, CEO of Ritholtz Wealth Management and a CNBC contributor, questioned the choice of Walgreens:

It’s not that there’s anything wrong with Alphabet and Amazon from a fundamental sense. Instead, their problem is that admitting them into the storied 30-stock benchmark would be like putting an elephant on the other side of a seesaw from a poodle.

The “weight” problem in this case is the dollar value of the two stocks and the issue it would cause to an index that is calculated based on share price.

Inserting the two companies, each of which trade well above $1,000 a share, into the Dow would skew the index too far away from the other 28 companies.

“Amazon, Google, even Facebook are probably never going to see the inside of the Dow, just because of price weightings,” said Nick Colas, co-founder of DataTrek Research. “Facebook at the margin could have been put in. But the worry is if it ends up being like Google, it will swamp the index.”

The Dow is considered a price-weighted index. The higher a company’s stock price, the more influence it has on the Dow’s direction.

At present, Boeing, which opened Wednesday at $346 a share, holds about a 9.5 percent weighting on the index.

Alphabet opened at $1,183 a share, implying that it would carry about three times the weight of Boeing. Amazon opened at $1,742, implying about five times the Boeing weight. (Facebook opened at $199.10 a share Wednesday, which would have put it just outside the top five in price terms on the Dow.)

Put them together in the index, and you get two companies that could account for half or more of the Dow’s movement on any given day. The two companies are included in the much broader S&P 500, which is weighted by company market cap. Tech comprises more than 26 percent of the S&P 500 market cap, by far the most of any sector.

The only way the Dow could ever accommodate Alphabet and Amazon would be through share splits, and Colas said that is unlikely.

“There’s a reason why they’re $1,000 each. They have no intention of splitting the stocks,” he said. “Indexers love high stock prices.”

That’s because ETFs pay fees on shares traded. Fewer trades are required on high-priced stocks to maintain the proper balance within the funds.

As for the General Electric move, officials at S&P Dow Jones Indices said the company had simply become too low in price to be considered a valid component anymore. GE opened Wednesday at $12.76 a share, meaning it held a 0.36 percent weighting. As a demonstration, the stock was down 1.1 percent after the first two hours of trading, but subtracted less than a point from the Dow’s performance.

Walgreens, by contrast, opened at $66.72, meaning its weighting will be close to 2 percent of the index.

The company “will be more representative of the consumer and health care sectors of the U.S. economy,” David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices, said in a statement. The change “will make the index a better measure of the economy and the stock market.”

As for the Dow on an existential level, not having two of the most dominant companies in today’s economy probably won’t stop it from continuing to be the most widely followed market measure for the public.

“The Dow will always be relevant because it is the oldest measure of the stock market and the number most retail investors know,” Colas said. “It is therefore the primary transmission mechanism between the financial economy and the real economy. People think the Dow is the market and the market is the Dow, and I don’t think that’s going away anytime soon.”

Source: Investment Cnbc
Here's why Google and Amazon probably will never be included in the Dow

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