The Dow Jones Industrial Average has hit an all-time high, as anybody who has seen the headlines splashed across the front of this and many other newspapers will know. But should we care about this landmark?
No. The Dow’s methodological flaws are overwhelming and there is no reason for anyone to follow it. That it still generates so much attention is attributable to inertia and groupthink. What is the problem with the Dow? As an index of only 30 stocks, the Dow is not broadly diversified and is not representative of the US stock market as a whole (the S&P 500, the world’s most widely followed index, is better for that purpose). Its stocks are not uniformly large enough to qualify as a “mega-cap” index, varying from Alcoa ($9bn) to ExxonMobil ($399bn). Try the Russell Top 50 instead. Neither, despite the name, is it a true industrial index (the S&P 500 industrials sub-index might be better).
Crucially, the Dow’s illogically chosen members are weighted by their share price, rather than their market valuation. This means companies that happen to have a high share price can outweigh larger companies with a lower price per share. This is ludicrous. For example. IBM now accounts for 11.1 per cent of the Dow, and has a market value of $228.7bn. ExxonMobil, back as the world’s largest company following the decline of Apple (never a Dow member), has a market cap of $398.5bn, but a Dow weighting of only 4.8 per cent. Microsoft, a slightly larger company than IBM these days at $235.8bn, accounts for only 1.5 per cent of the Dow. Meanwhile, Caterpillar outweighs both ExxonMobil and Microsoft, despite having a market value of only $58.8bn.