Will Google Dethrone A King

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Indexes
  1. How the Dow works
  2. Why Google might become part of the Dow
  3. What happens when a stock joins the Dow
  4. The story does not end there
  5. In closing
Photo by Annie Spratt on Unsplash

In over 120 years, it has happened only 55 times.

The Dow Jones Industrial Average, more commonly known as “the Dow”, is one of the most iconic stock market indices, in spite of the fact that it measures the movement of a mere thirty US companies.

Those thirty companies, on the prestigious Dow, are seen as “major players” in the US economy. The index composition will change when the committee feels a company no longer reflects this image.

When one joins, one must leave.

How the Dow works

The Dow is a price-weighted index. In other words, the stock with the highest price has a larger impact/influence on the value of the index. The index calculation mirrors the relative position of every company based on the percentage of the index’s value it represents.

There is no absolute criteria for a company to be listed on the Dow. For inclusion consideration into this exclusive group, the company needs to:

  • Be a US company
  • Be listed on the NYSE or NASDAQ
  • Be an influencer in their sector
  • Account for a substantial share of the US economy
  • Be essential to society today
  • Have a stock price making it eligible for the price-weighted index

Why Google might become part of the Dow

With the stock announcement on February 1, 2022, of a 20-for-1 split, it puts Google (GOOG) in the right price range for inclusion in the Dow. The price of the existing stocks swings from $45 to $467. Google closed on February 18, 2022, at $2,609.35, divide that by 20 and we end up at $130.47, right in Dow territory.

Apple was included in the Dow after a stock split made the price more in line with other Dow stocks.

Google’s revenue in 2021 was over $257 billion, compare that with IBM’s (an existing Dow member) revenue of over $57 billion — I would say that qualifies them as accounting for a substantial share of the US economy. They are a US company, listed on the NASDAQ, essential to our society, and definitely an influencer in the Communication Services sector.

Yep, I would say they have a chance at becoming one of the select few.

What happens when a stock joins the Dow

When a company is listed on the Dow, the mutual funds that hold “the Dow” need to purchase the stock. With the buzz about the company being added to the Dow club and the mutual funds buying the stock, I assumed the price of the stock will go up.

I tested this theory with the most recent inductees. In 2020, Salesforce (CRM), Amgen (AMGN), and Honeywell (HON) became part of the Dow. The first announcement I could find was on August 24, 2020. The actual admittance to the Dow was on August 31, 2020.

I compared the closing cost from August 24 to August 31, and calculated the gains for these stocks. I also checked for a week later, after the change actually happened. The stocks did gain in value, with most of the gains coming from the week following the announcement.

Image by author

The story does not end there

As expected, the companies exiting the Dow, Exxon Mobile (XOM), Pfizer (PFE), and Raytheon (RTX) saw their stock prices fall. To be honest, I was surprised at how modest the decline was.

Image by author

Fast forward to today — from the time of the Dow change announcement to today, the stocks leaving the Dow have significantly rewarded their stockholders with handsome gains.

Image by author

In closing

I will be watching for the next Dow shakeup and give serious consideration to buying the exiting company on the price down swing. Just because the Dow committee chooses to kick out a company, that does not seem to influence the stock price in the long run.

Disclaimer: This article is for educational and informational purposes only. It is created to explain options you may have and should not be considered financial or legal advice. Consult a financial professional before acting upon any information in this article.