Has The Dow Jones Industrial Average Become Obsolete And Is It On Its Way Out?

The Dow Jones Industrial Average has long been criticized for serving as an inaccurate gauge for the U.S. economy. Yet as it remains widely known, the Dow is used every day by news outlets and investors as a measure of stock performance and, by extension, the health of the overall economy.

Still, the Dow has many critics.

For one thing, with only thirty stocks, the Dow is too small and not diverse enough to encompass the whole complex U.S. economy. (There are just under 3,000 listed companies trading on the New York Stock Exchange and about 3,250 trading on Nasdaq).

Moreover, some of the biggest and most influential companies in the world have no place in the Dow. Even Apple Inc. (AAPL) did not join the Dow until March 2015 four years after it reached the status of biggest company on the planet. (Apple replaced AT&T (T) In the Dow).

Microsoft (MSFT) and Intel (INTC) joined the Dow in 1999, becoming the first Nasdaq stocks to join the index.

But, now in 2020, two of the most dominant companies on earth – Google owner Alphabet Inc. (GOOGL) and Amazon.com Inc. (AMZN) – are still not in the Dow.

Dow components have traditionally been selected according to subjective criteria – big, blue-chip stocks widely known to the public and heavily traded by investors. But that cannot explain the exclusion of stocks like Amazon.

Moreover, the index also ignores entire industries – for example, it has no utility or real estate stocks.

Another problem with the Dow is that its components are price-weighted – which means that stocks with higher prices have a bigger impact on the Dow, regardless of their underlying market cap size.

For example, as of May 6, Apple had a market cap of about $1.31 trillion and its stock traded at about $302 per share. Meanwhile, Dow component UnitedHealth Group (UNH) has a market cap of about $277.4 billion, but trades at $292 per share.

Thus, even though Apple is nearly five times more valuable than UnitedHealth – and has far greater impact on the global economy -- the two stocks have a nearly similar weighting in the Dow.

In contrast, the S&P 500 index is cap-weighted and has almost 17 times as many companies as the Dow; which means that these two important indexes provide very different – and often conflicting – measurements of U.S. economic performance.

David Martin, managing partner of Purple Bridge Management, wrote in 2018 (after the Dow replaced General Electric (GE) with Walgreens Boots Alliance (WBA): “The price-weighted nature of the [Dow] makes it increasingly susceptible to factors that have more to do with market activities of individual corporations than broader market conditions.”

Martin also criticized the inclusion of Walgreens in the Dow, citing that it is not a “market innovator.”

“As a consumer retail outlet primarily for the pharmaceutical industry, the firm’s intellectual property holdings are negligible,” he wrote. “Where industry leaders have been focused on drug-interaction detection, drug counterfeiting, customizable dosing and the like, Walgreens is dependent on the technology of others.”

Ben Brown, writing in CCN.com, now thinks the coronavirus pandemic will make the Dow even more irrelevant. Brown opined that the Dow is a “terrible proxy” for the U.S. economy, while the Nasdaq 100 index, with its focus on innovative technological companies, may present a “better indicator of the modern, post-coronavirus world.”

The Dow’s brick-and-mortar retail components like Wal-Mart (WMT) and Walgreens will “struggle to adapt in a fully digital world, “ Brown wrote, while oil companies like Exxon Mobil (XOM) and Chevron (CVX) are “under severe pressure.” The current supply and demand shock in the oil industry “will take years to recover” he added.

In addition, the legacy health and pharmaceutical companies like Dow members Merck (MRK) and Pfizer (PFE) “can’t react quickly enough to this current crisis.”

Brown added that big banks like Dow members Goldman Sachs (GS) and JP Morgan (JPM) are “rapidly losing trust and credibility. Many Americans now trust tech companies more than their own bank.”

Brown also believes innovative bio-tech companies have more relevance than legacy pharma firms, while Main Street businesses are giving way to online retail (like Amazon).

Amazon’s exclusion from the Dow is somewhat perplexing – but not if one considers its high price (shares closed at more than $2,351 on Wednesday). If Amazon were in the index, its price fluctuations would impart an enormous influence on the Dow’s daily performance.

Amazon is, in fact, more than 73 times as expensive as the cheapest stock in the Dow, the similarly named chemical company Dow Inc. (DOW).

Then, consider Warren Buffett's massive conglomerate Berkshire Hathaway (BRK-A), whose Class A stock closed at $259,100 per share on Wednesday.

"If you put in Berkshire Hathaway [in the Dow], everything in the Dow could go to zero and we'd still be up that day," quipped Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

Another hugely influential company, Facebook (FB) is also excluded from the Dow.

“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.

Brown concluded: “When we emerge from this [coronavirus] crisis, we will live in a fully accelerated digital, tech-immersed economy. The outdated Dow Jones index will face enormous pressure.”

However, the Dow has some things going for it, and it is unlikely to disappear any time soon. For instance, it has been around for more than 120 years and is well known to investors and even the average person who does not even play the market. Thus, it has a very strong ‘brand’ recognition.

"The Dow is still the primary measure that Main Street uses to measure Wall Street. I don't see that changing for a long time," added Colas.