Two Methods that will Permanently Alter the Dow Jones Industrial Average on Friday (as originally written)
Over a century and a quarter, the renowned Dow Jones Industrial Average ( dropping by 2.58%) has served as a gauge for Wall Street's health. Over this period, it has evolved from an index consisting predominantly of industrial stocks, numbering a dozen, to one accommodating 30 diverse, multinational businesses.
Since its inauguration on May 26, 1896, the Dow Jones has undergone numerous transformations. Excluding business mergers of existing Dow components and simple name changes, there have been 52 instances of either adding or removing companies. The most recent of these changes involved the removal of pharmacy chain Walgreens Boots Alliance and the addition of e-commerce titan Amazon in late February.
On the eve of Friday, Nov. 8, the Dow will undergo its 53rd transformation.
Bonjour, Nvidia! Au revoir, Intel!
The most spectacular transformation was announced after market close on Nov. 1. Leading AI stock Nvidia ( falling by 1.14%) will be joining the Dow Jones Industrial Average, while venerable semiconductor stock Intel ( plummeting by 5.58%), which has been a part of the Dow since November 1999, will be given the boot.
Nvidia successfully completed a 10-for-1 forward stock split in June, which facilitated this addition to the Dow Jones. Without this split, Nvidia's share price would exceed $1,300, making it incompatible with the Dow's formula based on share prices.
It's clear that Nvidia's strong ties to AI made this move possible. Demand for the company's H100 graphics processing unit (GPU) and its successor GPU architecture, Blackwell, is so high that it has resulted in exceptional pricing power, enhancing Nvidia's gross margin.
Nvidia has also benefited from its CUDA software platform. This toolkit used by developers to optimize AI-GPUs has greatly contributed to keeping Nvidia's clients loyal to its solution ecosystem.
The primary concern with this addition is the potential for an AI bubble to burst, which could negatively impact Nvidia and, by extension, the Dow Jones Industrial Average.
Meanwhile, Intel has been lagging behind in the innovation arena, and it's paying the price. It now faces a daunting task as Nvidia holds a commanding lead in the data center GPU market share.
Furthermore, Intel's ambition to become the world's second-largest foundry services provider by the turn of the decade is a costly endeavor. Building the necessary infrastructure has led to significant losses for the former semiconductor industry leader.
On the positive side, Intel maintains its position as the leading market share holder in central processing units (CPUs) for personal computers (PCs), but it has nonetheless witnessed some erosion of its leading share due to the efforts of Advanced Micro Devices.
Though Intel does have a path to staging a comeback, it's likely to be a multiyear project. S&P Dow Jones Indices, the organization responsible for making decisions regarding the addition or removal of Dow components, apparently wasn't willing to wait for that to happen.
Salut, Sherwin-Williams! Touche, Dow, Inc.!
In addition to swapping semiconductor stocks, S&P Dow Jones Indices will be incorporating materials giant Sherwin-Williams ( dropping by 3.90%) into the iconic index and ushering out material science solutions company Dow Inc. ( easing by 1.03%) after the close of trading on Nov. 7.
Sherwin-Williams is well-known for its extensive line of painting and coating products, which it sells to residential, commercial, and industrial clients. Its eponymous brand is its most recognizable face, but it also owns the Valspar, Thompson's WaterSeal, and Krylon brands, among others.
Materials companies tend to be highly cyclical, and Sherwin-Williams is no exception. While demand may wane during economic downturns, the company reaps the benefits of the non-linearity of the economic cycle. Recessions are usually resolved within a year, but the typical economic expansion spans multiple years, leading to sustained demand for the company's products and increased pricing power.
Furthermore, Sherwin-Williams's management team is not averse to using acquisitions as a means to expand its reach and enhance its bottom line. A steady diet of bolt-on acquisitions, as well as the occasional major acquisition (such as the purchase of Valspar for $11.3 billion in 2017), has fueled global expansion and broadened its product portfolio.
In contrast, the departing Dow Inc. is the smallest company in the Dow Jones Industrial Average, with a market cap of $34 billion. For perspective, Sherwin-Williams boasts a market cap of $90 billion.
In August 2017, historical Dow component DuPont combined forces with Dow Chemical to establish DowDuPont, a conglomerate focusing on material sciences, specialty chemicals/products, and agriculture. However, in 2019, DowDuPont was divided into three distinct entities: DuPont, Corteva, and Dow Inc., the latter of which remained in the Dow Jones Industrial Average. Given its reduced significance by a third, it was only a matter of time before a worthy replacement for Dow Inc. emerged within the timeless index.
To further spark controversy, Sherwin-Williams has surpassed Dow Inc. in performance since the DowDuPont trio's separation. While Dow Inc. has witnessed a 2% decline, excluding its annual dividend yield nearly reaching 6%, Sherwin-Williams has soared by an astounding 150% (similarly exempting its dividend). It isn't unordinary for S&P Dow Jones Indices to expel components failing to boost the Dow Jones.
Share price holds sway in the Dow Jones Industrial Average
Excluding companies joining and leaving the Dow ahead of trading on November 8, the subsequent change involves the Dow's Divisor.
Market cap-related indexes such as the S&P 500 and tech-driven Nasdaq Composite assign greater significance to companies with larger market caps. For instance, a 5% increase or decrease in the world's largest publicly traded company, Apple (boasting a $3.37 trillion market cap), ought to have more impact on the S&P 500 compared to the index's tiniest component, Qorvo ($6.8 billion market cap), encountering a 5% fluctuation.
Conversely, the Dow Jones Industrial Average is a share price-focused index. In other words, market cap bears no relevance. What truly determines whether the index's point value escalates or decelerates is the summation of its 30 components' share prices. At the time of the November 1 close, Intel and Dow Inc., sporting two of the Dow's lowest share prices, exerted minimal impact.
The forthcoming entrants, Nvidia and Sherwin-Williams, will assume positions as the 22nd and 6th most powerful entities within the Dow, respectively, based on their share prices on November 1.
However, to accommodate the substantial share price disparities between Nvidia/Intel and Sherwin-Williams/Dow Inc., S&P Dow Jones Indices will necessitate modifying the Dow's Divisor, which translates a company's share price into Dow points.
In a matter of days, the indestructible Dow Jones Industrial Average will undergo a complete transformation.
In light of the forthcoming changes, investors will need to adjust their strategies to account for the inclusion of Nvidia and Sherwin-Williams in the Dow Jones Industrial Average, as well as the removal of Intel and Dow Inc. The addition of these companies could potentially shift the focus towards sectors such as AI and materials, impacting overall portfolio diversity and risk profiles.
Furthermore, the alterations to the Dow's Divisor to accommodate the new share prices of Nvidia and Sherwin-Williams could influence the index's sensitivity to market trends, affecting investment strategies based on share price movements in the Dow. It's essential for financiers to stay informed and review their investment plans accordingly to optimize their returns in this dynamic financial landscape.
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