by Dan Burrows | September 25, 2012 7:15 am
The Dow Jones Industrial Average is as storied as Fenway Park — and almost as old. Unfortunately, although it serves as easy shorthand for U.S. stock performance, the Dow fills that role about as well as a seat at Fenway accommodates the average American’s butt.
The so-called industrial average is too aged, too constrained and too poorly structured. As a result, it has become all but irrelevant to professional investors — and it should be to you, too.
The Dow is much in the news these days because of the latest change to the average. Kraft Foods (NASDAQ:KFT) is splitting into two companies, neither of which are big enough to be really Dow-worthy. As a result, the keepers of the average — now controlled, ironically, by Standard & Poor’s (NYSE:MHP) — pulled Kraft and replaced it with UnitedHealth Group (NYSE:UNH).
As we noted recently, it’s a reasonable choice. Throwing a health insurer into the blue-chip mix of 30 companies that comprise the Dow is a defensible nod to the growing importance of health care spending in the U.S. — a $2.7 trillion industry representing 18% of the economy.
But it also makes the Dow even more fusty and behind the curve when it comes to being a proxy for U.S. equities.
We at InvestorPlace advocated for a more modern, forward-looking, dynamic Dow — one that represents the rapidly changing landscape of the American economy and its digital future.
Throw Apple (NASDAQ:AAPL) in there, or Google (NASDAQ:GOOG), for crying out loud. Or, at the very least, maybe Comcast (NASDAQ:CMCSA).
After all, the Dow hasn’t been an “industrial” average for decades. Montgomery Burns might still own shares of former Dow components American Cotton Oil, Pacific Mail Steamship Co. and National Lead, but they have long been displaced by the likes of Verizon (NYSE:VZ), Cisco Systems (NASDAQ:CSCO) and Merck (NYSE:MRK).
The problem is that the Dow, unlike almost every other index out there, is weighted by price rather than market capitalization. You can’t stick Apple or Google in there because at $650 to $750 a share, those stocks would throw the index completely out of whack. It would no longer be the “Dow Jones Industrial Average, 30 blue chips representing the American economy and correlating decently with GDP over long periods of time.”
It would become the “Apple (and, uh, some other stuff) Average.”
The folks in charge of the Dow are aware of its increasing, if not already de facto, irrelevance, according to a report by The Financial Times.
“Not being able to deal with Apple, Google or for that matter Berkshire Hathaway (NYSE:BRK.A, BRK.B) is an issue,” said David Blitzer, chairman of the index committee for S&P DJ Indices, according to FT.com. “This is an issue that we’re just starting to think through and debate.”
The thing is, adding Apple or Google or even Berkshire Hathaway wouldn’t make the Dow all that much more appealing to most investors. It would just make it a much-less diversified version of the Nasdaq-100 or S&P 500.
In case you didn’t know, when pros talk about “the market,” they’re referring to the S&P 500. And when pro investors want to buy “the market,” they buy the SPDR S&P 500 ETF (NYSE:SPY). That gets them Apple, Google, Berkshire and another 497 stocks, capturing about 75% all U.S. equities.
If, on the other hand, they want a more concentrated bet on Apple, Google and lots of other hot Nasdaq stocks, they buy the PowerShares QQQ Trust ETF (NASDAQ:QQQ), which tracks the 100 largest non-financial stocks listed on the Nasdaq.
This gives you an idea of the relative importance and popularity of these market averages and indices:
Cue the sad trombone.
In short, no one buys the Dow. And why would they? If you were constructing a portfolio of just 30 companies, would you really take Hewlett-Packard (NYSE:HPQ) over Apple? And just who is dying to own Travelers (NYSE:TRV) instead of Warren Buffett’s Berkshire Hathaway?
Yes, the Dow has been around since 1896. It’s venerable as hell. The reflexive attachment to the name and the average is understandable.
But times change. Lots of things existed back then that we don’t have anymore, and no one misses them: gaslights, telegrams, smallpox.
We can live without the Dow. Professional investors already do.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
Source URL: http://investorplace.com/2012/09/why-its-time-to-ditch-the-dow-jones/
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