Walgreens: A Fragile Component of the Dow Industrials
Walgreens, currently a part of the 30-stock index, stands as the most vulnerable candidate for removal. It holds the smallest market capitalization and boasts the lowest share price amongst its counterparts.
Ever since Walgreens joined the Dow Industrials in June 2018, it has been a disastrous addition to the index. Its stock has plummeted by approximately 65% during this period.
In light of recent events, Walgreens’ stock has taken another hit. As of Thursday, it witnessed a 6.8% decline, reaching $23.84, subsequent to the company’s decision to reduce the dividend by 48% to 25 cents per quarter. This move was unsurprising to analysts and investors alike, who had anticipated it.
As we navigate through the year, potential changes to the composition of the Dow Industrials loom on the horizon. The most apparent contenders for admission are Google parent Alphabet and Amazon.com. Other notable possibilities include Berkshire Hathaway and Tesla. It has been more than three years since the last occurrence of component changes in the index.
While Walgreens is not alone in its vulnerability, other members at risk of removal are Travelers, Verizon Communications, and Intel. However, it is vital to note that S&P Dow Jones Indices refrains from commenting on potential alterations to its indexes.
Travelers stands as the next-most-vulnerable member for removal after Walgreens due to its second-lowest market value. The insurance industry’s significance in the stock market plays a role in this consideration.
Furthermore, when evaluating potential changes, S&P Dow Jones Indices places importance on stock price since components of the index are weighted based on stock price instead of market value. On the contrary, components of the S&P 500 index and other major equity indexes adhere to market value for their assessment.
As 2020 progresses, it remains to be seen whether the index committee at S&P Dow Jones Indices will proceed with modifying the Dow Industrials components. The final outcome carries significant implications for not only Walgreens but also the candidates vying for inclusion or potential removal from this highly regarded index.
Dow Jones Industrial Average: A Historical Perspective
The Dow Jones Industrial Average (DJIA) has a long and storied history, with its roots dating back to 1896. This index, which predates the modern computer era, utilizes a unique pricing method to calculate its value.
Price Weighting: Simple Yet Effective
Unlike many contemporary indices that utilize more complex algorithms, the DJIA’s price weighting methodology is relatively straightforward. The prices of the 30 components that make up the index are summed, and then multiplied by the inverse of the divisor. This calculation yields the current value of the DJIA, which stands at around 37,500.
This approach has its advantages and limitations. On one hand, it allows for a simple and efficient evaluation of the market’s performance. On the other hand, it also means that stocks with higher prices have a disproportionately larger impact on the index.
A Tale of Weightings
The price weighting structure of the DJIA becomes evident when examining the weightings of individual stocks. For instance, UnitedHealth Group holds the highest price among the components, trading at approximately $546 per share. As a result, it carries a weight that is more than 20 times greater than that of Walgreens.
This system has implications for stocks like Intel, which experienced impressive gains of around 90% last year. Despite this remarkable growth, Intel’s lower stock price meant that its impact on the DJIA was relatively limited.
Changes in Component Composition
The composition of the DJIA components has undergone several changes over the years. The most recent adjustment occurred in August 2020 when Salesforce.com, Honeywell, and Amgen were added, while Exxon Mobil, Raytheon Technologies (now RTX), and Pfizer were dropped.
Prior to this, the previous change took place in June 2018 with the addition of Walgreens and the removal of General Electric. Another notable modification occurred in March 2015 when Apple joined the index, replacing AT&T.
Remarkably, we are currently experiencing the longest period without a change in DJIA components since 2015.
The Influence of Tech Giants
While the DJIA is historically associated with industrial companies, contemporary market dynamics have led to the inclusion of technology giants. Alphabet and Amazon, ranked third and fourth respectively in terms of stock market capitalization, play a substantial role in the index. Their higher stock prices, hovering around $140, enable them to have a significant impact on the DJIA.
Conversely, Intel and Verizon, with their lower stock prices of approximately $47 and $39, respectively, do not carry as much weight in the index. However, Travelers, despite having a smaller market value, wields influence due to its share price of $195.
In conclusion, the DJIA’s long-standing history and price weighting methodology make it a unique and influential index. While it has evolved over time to reflect market realities, the impact of its components remains subject to their individual stock prices.
