Dow Jones rejects Google

My brother sent me a link (which you can read here) that mentioned that Google was not included in the Dow Jones Industrialized Average (DJIA) during recent changes to the index. The link gives the story and also posits that the real reason for the omission was not the official reason given, but rather that the Dow is actually a price-weighted index as opposed to being a market-cap weighted index like virtually all other indices.

A price-weighted index means that the index constituents are assigned a more significant weight in the index if the stock’s price is high. Originally there were only 11 constituents but now there are 30. It used to be you would just take the price of the 11 stocks and divide by 11 to give you the average but the Dow Jones Index was created in a time where there were no stock splits. Now, to account for splits and reverse-splits they publish what is known as the Dow Divisor – which is just a number that replaces the original 11 (or 30) that reflects the change in prices due to stock share re-organizations and not changes in company values.

I think it is best explained with an example. The current Dow Divisor is 0.122834016. So if a company changes in price of $5 (no matter what company it is) you divide $5 by 0.122834016 and you would get 40.71. This is the amount of change imparted on the Dow by that constituent.

Do you see the problem with adding Google? Since it is trading at $500-ish it would skew the results since a $5 change in Google’s stock price is 1% of it’s value and $5 in the change of a different stock that was trading at the $50 level would represent a 10% change in it’s value. Therefore a smaller move in Google’s stock (on a percentage basis) would overwhelm even significant percentage moves of other stocks.

Nonetheless, the Dow is watched like a hawk. Go figure…