It May Be Time To Fix The Dow

 |  Includes: AAPL, CSCO, DIA, V
by: Bill Maurer


The Dow 30's weights need some tweaking.

Visa's weight should not dominate much larger companies.

Apple's addition to the Dow could fix things.

Some stock splits could reduce weights of top components.

Earlier this year, I detailed how many were speculating that Apple's (NASDAQ:AAPL) stock split was an effort to get the tech giant into the Dow Jones Industrial Average (NYSEARCA:DIA). Of course, if you are going to add Apple, or any other stock to the index, that obviously would mean that another name must be booted. At that point, I speculated on two names that could be dropped from the index. Today, I'm here to re-evaluate the Dow situation, including the addition of Apple. I still think the Dow 30 could use some tweaking, and these changes would make the index a bit more representative of its components.

Power at the top:

Everyone knows that the Dow is a price weighted index. A stock in the index with a higher share price has more power than one with a lower stock price. The DIA ETF shows the weights of all of its components here, and the results may be a bit staggering to some. Credit card company Visa (NYSE:V) had a weight of more than 8.00% as of Tuesday, the largest weight in the index.

On the flip side, the lowest weight in the index as of Tuesday was Cisco Systems (NASDAQ:CSCO), which had a weight of less than 1.00%. Visa has a market cap that's a little higher than Cisco's, but the difference is less than 10%. However, on an annual basis, Cisco has about four times the annual sales of Visa. When it comes to the Dow, Visa carries more than 8.5 times the power of Cisco.

It gets even worse though when looking at the rest of the bottom of the index. As of Tuesday, the bottom six components (including Cisco) had a weight of 7.19%, which was roughly equal to the weight of the second largest holding, IBM (NYSE:IBM). These bottom six names have annual sales of more than $480 billion (current expectations for each name's fiscal year), while Visa's revenues are less than $13 billion. Additionally, these six names have a combined market cap of about $1.1 trillion. Visa's market cap isn't even $150 billion, yet Visa has about 10% more power than these six names combined.

I could go on and on with numerous cases of how things are slanted towards certain components, but I think the point is quite clear. We all know the Dow isn't a perfect index, and there are some who say it should be abolished completely. It is funny that the Dow 30 is the index that most people mention first when talking about US markets, despite the fact that it is based on the fewest number of components. I don't think the Dow needs a complete overhaul, but I think a few simple changes might make the index a bit better.

A few simple fixes:

Obviously, a lot of people would like to see Apple in the Dow. Why not put a company in that has a market cap of almost $600 billion and almost $200 billion in annual sales? Apple does more sales in Japan each year than Visa does worldwide in a year. With Apple trading a little below $100 currently, it wouldn't get a tremendous weight, as it currently would compare to Johnson & Johnson (NYSE:JNJ), which holds a weight of less than 4%. If we take out Cisco Systems, the lowest weight in the index, it would balance things out a bit more overall. This would reduce the weight of the top components, which makes the index less reliant on Visa. Additionally, you'd be swapping a tech company for another tech name.

Unfortunately, this also would reduce the weights of bottom components as well. So the second solution I would propose is to make the top few components split their stocks. These don't need to be crazy splits, like a 2 for 1 for Visa. But make Visa split so that instead of being a $215 stock, it's a $150 stock, or maybe even $175. Make the top three names in the Dow shave at least 15%-20% off their share price. Putting Visa at $150 would give it about six times the power of Cisco Systems currently. That would be a lot better than the roughly 8.5 times or so it has now. This would balance the index out a little more, so that all other components in the index would matter more.

Final thoughts:

I don't believe that the Dow needs a complete overhaul, but a couple of small changes might be a big improvement. No offense to Visa, but the company shouldn't have more power than names that have revenues of nearly half a trillion a year and combined market caps of over a trillion. It's probably time for Apple to get into the Dow as well, and potentially time for Cisco to go. Between one index swap and a few stock splits, the Dow could get to a point where all of its components are more properly balanced.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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