A successful investor can differentiate themselves from others through their ability to accurately forecast the future, but these predictive skills aren’t solely useful for anticipating stock price movements and underlying market shifts. By scouring the markets for prospective companies that could be eligible to join the Dow Jones Industrial Average, traders may be able to invest in a stock at the ideal moment before the bandwagon rolls into town.
The importance of the Dow Jones
The Dow Jones consists of 30 of the largest American companies, with the index boasting a total market capitalization of $8.33 trillion. These companies are almost always household names, with Apple, Nike, and McDonald’s all represented on the Dow Jones. The substantial prestige of these names makes the Dow Jones Industrial Average stocks some of the most widely traded in the world, as a significant proportion of investors enjoy buying and selling shares in familiar companies.
The financial contributions of these 30 companies are so vast that a bad day for business inevitably means a bad day for the US economy – and vice versa. This is why news bulletins often refer to price movements in the live Dow Jones chart, using the fortunes of these 30 companies to provide context for key developments.
The factors that determine a company’s suitability
An American company with an impressive reputation, deep pockets, and an upwardly mobile share price may be deemed ready to make the jump to the Dow. In 2018, General Electric was dropped from the Dow and replaced by Walgreens Boot Alliance. G.E. was the last remaining original member of the Dow, but its crashing share price and declining reputation meant that it had a negligible impact on the price-weighted index of the Dow.
Citigroup was dropped from the DJIA in 2008 when the financial crisis stripped the bank of 90% of its market capitalization, while Alcoa’s removal in 2013 was facilitated by the company having the lowest market cap on the DJIA at the time. A company that can make more meaningful contributions to the Dow through strong shares and high market capitalization is, therefore, the ideal candidate to join the index.
It is worth noting that companies with stocks at astronomical levels, such as Google, are not deemed useful for the DJIA, as their high-flying shares may distort the index and make it less indicative of the American economy as a whole. Instead, a company of the stature of Walgreens was considered ideal to become the most recent entrant to the Dow in 2018. David Blitzer, managing director at S&P Dow Jones Indices, stated that Walgreens’ addition would help the index to become “more representative of the consumer and healthcare sectors” in the American economy.
That idea of diversification is also key. The industries that provide the foundations to the American economy should all be represented on the Dow, which is why Travelers Insurance slotted in for Citigroup to fly the flag for the financial world. Nike stepped up as Alcoa departed, with the former giving the Dow a foothold in the apparel industry. Alcoa was deemed vulnerable because tech companies were already well covered.
How this can help investors
Investors should, therefore, look for American companies with strong (but not too strong) shares, ample resources, and a respected name. As the case of Walgreens shows, a large company from an industry underrepresented on the DJIA may also be considered to ensure that the Dow remains as representative of the American economy as possible.
If investors want to beat their fellow traders in terms of securing the best value shares, keeping an eye on companies that meet these criteria could be crucial. It is also important to look for poor performers on the Dow to be ready for a potential switch, as one company’s crisis could provide another with the opportunity to join the DJIA.