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With a gain of 0.04% on Thursday, the Dow Jones finally broke its 10-day losing streak, the worst since the 1970s.
This week’s performance was another reminder of why the historically important index is now more historic than important, having long since ceded its role to the S&P 500.
Before the market’s dramatic response to the Fed on Wednesday, the Dow Jones was at odds with the S&P 500 and Nasdaq and in a historic funk.
Much of the why came from a dose of bad luck: While almost all of the Magnificent Seven stocks rose, the Dow exposure did not include the two biggest winners – Tesla and Alphabet – and instead Nvidia, which has had a rough patch has. month. (The Dow recently added Nvidia in November, kicking out a struggling Intel.)
In addition, the Dow Jones Industrial Average had UnitedHealthcare, which fell about 20% this month, making losses twice as large as those of the next worst performer, Chevron.
But this bad luck belies the ‘real problem’, which for decades was the great advantage of the index: the price-weighted indexing. Instead of using the market cap system, the index is calculated based on ticker prices, which only relate to the actual valuation when you take into account the number of shares there are. Great for the pre-internet age, when you had to do quick math with little information, but it now produces some stunning statistics, as our Chart of the Week shows.
For example, because it trades at nearly $500 per share, UnitedHealthcare (market cap $452 billion) has the second-heaviest weighting on the Dow Jones at 7%. Microsoft, with a lower share price, is in third place, with 6%. But Microsoft is worth almost seven times as much.
You can do this for many of these companies: Paint company Sherwin Williams weighs about 1.5 times more than Apple and is worth just 2.3% of what the tech giant is.
And prices don’t just rank stocks for weighting purposes; they make them move differently. A $10 move is the same no matter which company we’re talking about, even if it’s a huge 50% jump for a $20 stock and a much smaller 5% deal for a $200 stock. The index doesn’t care.
The Dow is not the only index that uses this method. Japan’s Nikkei 225 is also price-weighted instead of using the market capitalization method which uses the total value of its components, weighted by size.
Keeping this in mind, it’s useful to parse the headlines and statistics about the state of the market, as every now and then we get another episode of “Price Weighted Indexing Gone Wrong.”
