Monday, February 23, 2009

Pressure to Re-evaluate Dow Index

The Wall Street Journal - As the Dow Jones Industrial Average hits lows not seen since the dot-com bust, Wall Street is getting antsy about its inclusion of low-priced stocks that some traders and analysts believe should be yanked from the 30-stock average.

Their gripes are based in simple arithmetic, since the average is weighted according to the nominal price quotes of its 30 components, hand-picked by top editors at Dow Jones & Co., which also publishes the Wall Street Journal.

With five stocks in the Dow trading under $10 – Bank of America, Citigroup, Alcoa, General Motors, and, as of today, General Electric – the average’s detractors say it’s become a skewed indicator of the market. They want the runts replaced for essentially the same reason the editors would never add in an extremely high-priced stock like Berkshire Hathaway, now trading above $76,000 a share, or Google, at $340.

“The committee is just not doing its job by leaving these names in,” said James Bianco, president of Bianco Research in Chicago, which recently sent a note to clients analyzing the impact of low-priced stocks in the Dow. He notes that a simultaneous drop in all five sub-$10 Dow components to zero would only cause the average to fall by less than 200 points. However, a 100% decline in the Dow’s most high-priced component, IBM, would cause a drop of more than 700 points.

In the eyes of many investors these days, several of the Dow’s sub-$10 stocks are indeed candidates to go to zero if the government nationalizes them, wiping out private shareholders’ equity. Bank of America and Citigroup are most often cited by traders as candidates for a takeover, though executives and government officials have attempted to dissuade investors from believing that will happen.

Dow Jones Indexes removed American International Group from the industrial average last fall after it received bailout funds that amounted to a de facto nationalization. Mr. Prestbo said the index committee is ready to remove other names quickly if a similar scenario comes to pass, but the committee won’t make moves in anticipation of any government takeovers.

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