Dow Jones industrial average undergoing makeover

One of the oldest and best known gauges of the U.S. stock market is getting a makeover. The Dow Jones industrial average, which tracks 30 large, publicly traded companies, is replacing three of the stocks in a shake-up meant to reflect massive shifts in the economy and the technology sector’s growing dominance in market leadership and American society.

“The big picture is that the Dow components have been curated: Old Economy stocks are being replaced by New Economy stocks,” said Kristina Hooper, chief global market strategist at Invesco.

Here are five takeaways about the changes announced Monday:

Why is this happening?

The reconfiguration was prompted by Apple’s coming 4-to-1 stock split. On Aug. 31, existing Apple shareholders will be given three shares for every one they own. While the split does not change the value of Apple’s business, it will divide its share price—which currently hovers near $500—by four. According to S&P Dow Jones Indices, the company that oversees the Dow, Apple’s stock split will reduce the tech sector’s representation in the index.

The shake-up is designed to offset the impact of the stock split to ensure the Dow is giving enough weight to tech companies.

Apple itself underscores the tremendous growth that tech giants have delivered to investors. Just two years ago the iPhone-maker became the first U.S. publicly traded company to be valued at $1 trillion. Last week, it became the first to reach $2 trillion. While entire segments of the economy face uncertain futures as the pandemic still rages across the country, Apple and other tech companies have never faired better on Wall Street.

Which companies are at play?

To help rebalance the index, three companies are coming on and three coming off, including the longest standing component.

The Dow is deleting oil giant ExxonMobil; pharmaceutical company Pfizer; and the aerospace and defense manufacturer Raytheon Technologies. They will be replaced by Salesforce, the cloud computing company; Amgen, the biotechnology firm; and Honeywell International, the aerospace and industrial manufacturer.

“They also help diversify the index by removing overlap between companies of similar scope and adding new types of businesses that better reflect the American economy,” S&P said in a news release announcing the changes.

How is the Dow different from other indexes?

The Dow is one of three major indexes that investors, policymakers and businesses use to gauge the U.S. stock market and as an indicator of where the U.S. economy is heading. The Dow comprises far fewer companies than the Standard & Poor’s 500 index which, follows 505, and Nasdaq composite, which tracks more than 2,500. The Dow also weights its stocks by price rather than market capitalization. So Dow components with more expensive shares have more influence in the index’s daily ups and downs. After Apple’s stock split takes effect, UnitedHealth Group, which is trading at more than $300, will be the new price leader.

“The catalyst for the changes to the Dow is Apple’s stock split,” Hooper said. “Because the Dow is a price-weighted index, Apple —and therefore the technology sector—will have far less representation in the Dow.”

How does this affect investors?

The Dow’s change-up will not actually affect its value. The S&P will change what is known as the “Dow divisor,” the number it uses to calculate the Dow’s level. It is this figure that is multiplied by the prices of Dow stocks to calculate where the Dow stands in the market. Of the roughly half of Americans who have money in the stock market, their investments are largely tied up in retirement funds, many of which attempt to broadly track the market. So the change will not affect everyday investors.

But the additions and subtractions of Dow companies do reflect broader trends in the U.S. economy and society.

“Being removed is an oil and gas company, a defense contractor and a traditional pharmaceutical company,” Hooper explained. “They will be replaced by a software company, a biotech company and manufacturing and technology company.”

Exxon was once the most highly valued publicly traded company by market capitalization. Exxon, which has been part of the Dow for nearly a century, has lost 40% of its value this year amid diminishing demand for fossil fuel.

“It shows you how the giants can fall,” said Jeremy Siegel, a finance professor at the Wharton School of the University of Pennsylvania, on CNBC’s “Squawk Box,” Tuesday.

On Wall Street and within the broader culture, new corporate giants have displaced energy and aerospace companies at the top of the food chain. Six megacap technology companies—Apple, Facebook, Amazon, Netflix, Microsoft and Google’s parent, Alphabet, now account for more than one-quarter of the S&P’s value.

What does it mean to be a Dow company?

The inclusion in the Dow is likely to boost a company’s reputation, drive potential business and make it more of a household name, Siegel said of Salesforce.

“Just in terms of name recognition, I think a lot of people are going to look it up and say ‘Hey what is Salesforce do? Maybe if Dow thinks it’s good we should use it.”

The change in the makeup of the Dow will begin on the morning of trading on Aug. 31. And investors have already reacted by flocking to the new Dow companies and fleeing the ones on their way out.

Shares of Salesforce and Honeywell gained more than 3% during morning trading, and Amgen gained more than four. Meanwhile, Exxon and Raytheon fell by more than 3% as Pfizer dropped by more than 1.

Unlike the Nasdaq and the S&P, which have been buoyed by the growth of the tech giants, the Dow has still not recovered from the losses triggered by the coronavirus. The index is down roughly 4% from is previous high, set in February.

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