This posting was prompted by seeing the Dow Jones Industrial Average change out 3 of its component stocks. Gone are Alcoa, Bank of America, and Hewlett Packard. In are Nike, Visa, and Goldman Sachs. This change was announced on September 10th, 2013 for effect on September 23, 2013. It isn't the first time, nor will it be the last, that the DOW will make adjustments. But that does leave me with a rather uncomfortable question. How valid is it to compare the DOW of September 23, 2013 with the Dow of September 22nd. 2013? Had Alcoa, BofA and H-P still been in the index on September 23, then the DOW would have one value, but since they aren't it would have another.
The way the "magic" occurs is that the DOW is a price weighted index. The idea is that a shift of $1 in the price of any stock will cause the index to shift a certain number of points. It doesn't matter which stock it is.To prevent any discontinuities, structural activities (stock splits, acquisitions, divestitures) and additions/removals to the index cause a weighting factor to change. From March 2013 to now the weighting factor has been that a $1 change in any stock price will move the index 7.7 points. From September 23, 2013 onwards a $1 change in a stock price will cause a movement of 6.5 points
So as we compare DOW index values over the years, we at least need to be aware that it isn't a single seamless whole with the same stocks at the same weighting all the time.
As we look at index data in our own businesses, we also need to realize that the way an index is calculated can affect the perception of the underlying reality that has been abstracted by the index.
The way the "magic" occurs is that the DOW is a price weighted index. The idea is that a shift of $1 in the price of any stock will cause the index to shift a certain number of points. It doesn't matter which stock it is.To prevent any discontinuities, structural activities (stock splits, acquisitions, divestitures) and additions/removals to the index cause a weighting factor to change. From March 2013 to now the weighting factor has been that a $1 change in any stock price will move the index 7.7 points. From September 23, 2013 onwards a $1 change in a stock price will cause a movement of 6.5 points
So as we compare DOW index values over the years, we at least need to be aware that it isn't a single seamless whole with the same stocks at the same weighting all the time.
As we look at index data in our own businesses, we also need to realize that the way an index is calculated can affect the perception of the underlying reality that has been abstracted by the index.
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