A recent change in the composition of the Dow Jones Industrial Average (DJIA), often referred to as the Dow, is likely to significantly alter the average’s future returns. On June 29, Alphabet Inc. (GOOGL) replaced Verizon Communications Inc. (VZ) as a component of the average, explains Bob Carlson, editor of Retirement Watch.
The class A shares of Alphabet are in the Dow, while the Class C shares with the ticker GOOG are not. VZ has lagged the market indexes for years despite being one of the top telecommunication firms and having a high dividend yield. GOOGL has been one of the largest and fastest-growing businesses in the world for years.
Alphabet Inc. (GOOGL)
It is important to understand that the Dow is an average, not an index. The DJIA was created to simulate the performance of the broader stock market long before computers existed. A method of estimating the market that could be calculated manually each day (or more often) was needed. An average of the prices of 30 large companies was selected as a proxy for the overall stock market.
Because the DJIA is an average of the prices of its component stocks, price determines a stock’s weight in the average. The higher the price, the greater a stock’s weight in the average.
GOOGL is about 4% of the DJIA and is its sixth- or seventh-largest component, depending on the day. By comparison, it is about 3.27% of the S&P 500 Index (^SPX) and its fifth-largest component. VZ, with a share price around $45, had a negligible weighting in the average.
Both GOOGL and VZ are in the communication services sector. But they have very different businesses. The change will boost the DJIA’s exposure to digital advertising, cloud computing, and AI. The addition of GOOGL also means five of the Magnificent Seven stocks now are in the DJIA, including Nvidia Corp. (NVDA), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), and Microsoft Corp. (MSFT).
The DJIA has lagged the S&P 500 in total returns for a long time. The Dow’s owners probably want to earn more competitive returns without eliminating the simplicity of the average.
