Amazon Joins the Dow

For those of you who would prefer to listen:

Amazon entered the Dow this week. It’s another major milestone for the innovative American company. It’s a prestigious achievement; A badge of honor in US Stock Market history. There are only 30 stocks in the Dow Jones Industrial Average at any given time. They do change periodically. Amazon, a longtime NASDAQ member, entered the S&P 500 in 2005.

Stock selection for the Dow is not governed by a strict set of rules. It’s said, the committee focuses on a company’s reputation, its history of growth, its interest to investors and its sector representation within the broader Market. The stock does have to be a current member of the S&P 500. But that’s standard for large, established American companies. In other words, being added to the Dow is pretty subjective. 

Adjustments to the Dow Jones Industrial Average have 2 objectives: 

  • Make the Dow more reflective of today’s Economy.
  • Narrow the discrepancy of component stock prices.

The Dow Jones Industrial Average took its current form in May of 1896. It was born over a century after the New York Stock Exchange was founded in lower Manhattan at the corner of Wall and Broad. Its roots go back to 1884. A guy named Charles Dow created it by hand. It was the first way to track the Stock Market. There were just 12 stocks in the original list. 10 of them were railroads. He later split out railroads to form the Dow transports. What was left was a basket of industrial stocks. They ranged from Oil and Steel to Leather and Sugar. Dow used simple math. He added up the stock prices, divided it by 12 and then circulated the price movement in his daily news rag called the “Customers’ Afternoon Letter.” Today, that once tiny paper is known as The Wall Street Journal. The Dow Jones Industrial Average closed at 28 on its first official day.

Since its inception, the Dow has changed its components dozens of times. The first change occurred just 3 months after the index was created. General Electric was one of the original Dow stocks. GE was long considered the bluest of Blue Chips. But the company had a volatile history with the DJIA. GE was removed from the Dow twice in the index’s early days and was removed again in 2018. It still remains absent.

The Dow increased the number of stocks to 30 in 1928. That was near the height of the Roaring 20s. There are a number of current Dow stocks that were also discarded at one point in time but were added back later. IBM joined the Dow in 1932, but it was out for 4 decades, from 1939 to 1979, before returning for good. Coca-Cola also joined the Dow in 1932, but that only lasted 3 years. Coke made its return in 1987. AT&T was removed from the Dow in 1928, 2004 and again in 2015. AT&T is still not a Dow stock, and there is little chance it returns.

The Dow is an average, not an index. Back then, Charles Dow did everything by hand. Computers didn’t exist. Information flow was slow. The Dow is weighted by the share price of the stocks instead of the companies’ total market value. Over the years, adjustments have been made to account for things like dividends and stock splits. The biggest addition is known as the “Dow Divisor.” It is currently approximately 6.5. So each Dollar change in any Dow component moves the average by about 6.5 points. For you fellow number geeks, if you divide 1 by the divisor, you see how much each Dollar change in any Dow component moves the Dow. It is precisely 0.15172752595384 today.

Here’s the important part: Amazon closed Friday at $178. If Amazon rises $1, it is responsible for 6.5 Dow points. It’s the same for every Dow component. But a $1 move on a $178 stock is just 0.5%. Verizon is now the lowest-priced stock in the Dow 30, trading at $40 heading into the weekend. A $1 move on Verizon is a 2.5% change in price, which is much more material to the stock, yet has the same impact on the Dow average. For comparison, a 2.5% move for Amazon is over $4. So, the higher-priced stocks have much more influence on the Dow than the lower. You can see it’s not a perfect representation of the overall Stock Market.

As Technology has become a larger part of America’s Economy and Stock Market over the decades, the industrial-heavy Dow has perpetually been playing catch-up in gaining more exposure to the fastest-growing companies. In 1999, Microsoft and Intel joined the Dow, replacing Sears Roebuck and Goodyear Tires.

To address the increasing irrelevance of the price-weighted Dow Jones Industrial Average, the S&P 500 was created in 1957. It is a product of and for more modern times. The S&P 500 consists of the 500 largest publicly traded American companies. Here’s the other thing: Nearly $6 Trillion of investor money is indexed to the S&P 500. Only $87 Billion is tied to the Dow. That’s a minuscule 1.5% as much indexed to the Dow.

The simple strategy for investors everywhere is to buy low and sell high. Everyone knows that. However, the Dow has earned a reputation of buying high and selling low. Being knocked out from the Dow isn’t as bad as you might think.

There is a thing called the “Dow Jinx”. Stocks that get booted out tend to do better over the next year than those that enter. The last change saw Exxon exit and Salesforce added in 2020. Exxon is up 150% since its Dow ejection, while Salesforce is up 15%. GE has more than doubled since being kicked out of the Dow in 2018. It took 15 years after being added to the Dow for Microsoft’s stock to hit a new high. Intel has yet to. Apple entered the Dow in 2015, just after its stock split. Apple has successfully bucked the Dow Jinx trend.

Amazon came sailing into the Dow up 70% in 2023. Walgreens Boots Alliance was kicked out. Its stock was down 40% last year and, down 50% the previous 3. Walgreens had the lowest weight in the Dow. Walgreens’ Dow tenure lasted less than 6 years. That is a very short existence for a Dow component. Walgreens got the boot and lost its alliance. Sorry, I just couldn’t resist…

To the overall Stock Market, the Dow doesn’t really matter. Except though, it kind of does. The vast majority of the population are Dow watchers. Chances are, you’re probably one of them. The Dow is by far the most followed and quoted group in the Stock Market. But with just 30 companies in a price-weighted fashion, the Dow does not represent the United States Stock Market. But being a Dow stock still has prestige.

The S&P and Nasdaq both closed out February at record highs. The Dow fell just short. The rally capped off 4 straight months of gains. It’s been a strong start for investors to 2024. March began with a bang too. The previously expected interest rate cuts aren’t coming. At least not for a bit. Anticipation of lower rates is what fueled the year-end rally.

The Market has now priced out roughly half of the easing that was expected early in the year and is now largely in line with Fed guidance. That’s looking like 3 rate cuts in 2024. The first likely comes in the Summer. For now, rates and yields stay higher. Stocks have not been deterred by higher yields and nagging inflation. Rates have not been the biggest driver. Artificial Intelligence (AI) remains the undeniable secular growth theme. It’s becoming reality in the new millennium.

Innovation is not new for America. The Stock Market has always been driven by secular growth themes. It was the Railroads that drove the Dow in its early days. It accelerated the growth and expansion from coast-to-coast. The 19th-century Economy boomed. It was the Industrial Age. Next came the advancement of automobiles and consumer companies. Energy fueled exponential 20th-century growth. Computers, software and chips triggered the expansion of the World Wide Web. The Internet changed everything. It launched us into the Digital Age in the 21st century. Today, it’s all about AI.

From generation to generation, century upon century, innovation has led to expansion. It’s America’s Growth Story. Charles Dow knew then what we all know now. This is all incredibly investable.

Have a nice weekend. We’ll be back, dark and early on Monday.

Mike

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