This article is part of the series

Emac's Bottom Line

Big Changes Come to the Dow

By Emac's Bottom LineFOXBusiness

Alcoa (NYSE:AA), Hewlett-Packard (NYSE:HPQ) and Bank of America Corp. (NYSE:BAC) will be out of the Dow Jones Industrial Average starting September 23. They'll be replaced by Nike (NYSE:NKE), Visa (NYSE:V) and Goldman Sachs (NYSE:GS). It's the biggest shakeup of the 30-stock index in almost a decade.

The changes "were prompted by the low stock price of the three companies slated for removal and the Index Committee's desire to diversify the sector and industry group representation of the index," S&P Dow Jones Indices LLC, the company that oversees the Dow, said in a statement.

Continue Reading Below

While their performance has been mixed this year -- H-P is up more than 50%, while Alcoa is down almost 7% -- all three departing stocks have underperformed the broader stock market in recent years.

Shares of New York aluminum maker Alcoa closed Monday at $8.08, down from $40 as recently as 2007. H-P, the Palo Alto, Calif., computer maker, ended at $22.36, down from $50 in 2010. Bank of America, of Charlotte, N.C., was at $14.48, down from $50 in 2007.

If the changes were made at the beginning of the year, the Dow would be higher by 558 points, according to Charles Brady, senior editor at FOX Business.

Over the last decade, the Dow components have changed seven times. This Dow move is the biggest since April 2004, when American International Group Inc., Pfizer and Verizon Communications replaced AT&T, Eastman Kodak. and International Paper Co.

The Dow index committee said on the conference call explaining the changes that they will “make the Dow a better measure of what’s going on in the market,” that “typically you may see the three stocks going in get a slight bump up, and the three going out get a slight push down.” The Dow index managers also said “those movements will likely dissipate by end of this week, and not have a permanent effect.”

Why the changes? “If we only dropped Alcoa, we would have come back and made more changes anyway, better move to do all at once,” an index committee official said, adding, “we’ve been looking at this with some care. We went through a number of scenarios, we considered eight changes, but we considered that overly dramatic.”

The official said: “If we took more out, it would have raised concerns to us and a lot of eyebrows also would have been raised if we made even more changes, given the size of the market cap of stocks that could have been replaced.” For example, the next lowest-priced stock behind Hewlett Packard is Intel, which has a market cap that is two and a half times the market cap of H-P. The official also said that “putting in Google would completely distort the index given its market cap.”

Listing Apple or Google, or any other high-flying stock, in the Dow would be difficult, due to the way the index is calculated. Rather than weighting component companies based on market value, as the Standard & Poor's 500 and most other major indexes do, the Dow weights its 30 components based on the price of their shares.

The way Apple's shares currently trade, it would overwhelm the Dow with about a 25% weighting, double the sway of current Dow component IBM.  Apple alone could move the Dow regularly by 100 points or more, given its recent trading swings. And even if Google does a planned stock split cutting its share price in half, it would still command a nearly 20% weighting in the average.

It’s been expected for some time that Alcoa, Bank of America and Hewlett-Packard would get yanked. Given Alcoa’s share price, it has very little impact on the Dow. A 50% move in Alcoa would push the index up by just a mere 40 points or so.

What do you think?

Click the button below to comment on this article.