Cheap stocks spark debate over Dow index’s utility
Deepa Seetharaman 23 February 2009
NEW YORK (Reuters) – There was a time when a tumble below $10 in the share price of a company in the Dow Jones industrial average meant ignominy.
Now, after vertiginous stock market falls in recent months, five of the venerable index’s 30 components are trading under that price, including its two oldest members, conglomerate General Electric and automaker General Motors.
Citigroup stock plunged below $2 on Friday, making it cheaper than a medium cup of coffee at Starbucks.
Continued membership in the Dow of these battered stocks, which include aluminum producer Alcoa and Bank of America, is raising questions over whether the index should overhaul its lineup to include the likes of bank Goldman Sachs or Internet company Google.
It has also stoked a decades-old debate over whether the 112-year-old index is really an accurate snapshot of the overall U.S. economy.
“It’s been out of touch for a while,” said Jocelynn Drake, an equities analyst at Schaeffer’s Investment Research.
“There are companies out there that are more significant to the market and they have not appeared in the Dow and there are others that should have been kicked out.”
But expelling stocks because they are cheap would fail “to tell the story of the U.S. economy,” said John Prestbo, editor and executive director of the Dow Jones Indexes.
“Companies that have sunk so far down we’ve kept because they were still telling the story of the financial industry,” said Prestbo, who helps select the companies in the Dow.
He declined to comment on the possibility of an index makeover but did not rule out the idea.
ELITE GROUP FACES CHANGE
Financial journalist Charles Dow created the index in 1896 to help investors track market trends in the absence of other metrics. Most investors, however, now use broader indexes such as the S&P 500 to follow stocks.
Still, the Dow is the most widely watched measure of the U.S. stock market and its members are considered an elite fraternity representing the best names in corporate America.
The index is rarely altered but when it is, it is done so at the discretion of a team of editors at The Wall Street Journal. Changes in its makeup affect funds such as Diamonds Trust, an exchange traded fund that mirrors the Dow.
It was last changed in September when food company Kraft Foods replaced American International Group after the U.S. government took a large stake in the insurer.
Now as shares of Bank of America and Citigroup plumb fresh lows, criticism is growing that the Dow has lost its luster.
“I was surprised Citigroup was still a part of it,” analyst Drake said. “GM is another one. I understand them trying to get a slice of the automotive sector but ... it’s not a market mover anymore.”
Drake added that Google and computer giant Apple are more influential in the stock market.
Citigroup and Bank of America should be swapped for a financial company with a higher share price, such as insurer The Travelers Co or Goldman, said James Bianco, chief executive officer of Bianco Research Securities.
This would paint a more accurate picture of the financial sector because the Dow is a price-weighted index, where cheaper stocks count for less. For every $1 lost on a Dow component’s stock price, the index sheds roughly 8 points.
That means if the three current cheapest stocks -- Citigroup, Bank of America and GM -- shrank to zero, the Dow would lose less than 60 points or 0.8 percent based on Friday’s close, a sign of how much the sector has declined.
“The financials have a much larger bearing on the market than is reflected in the Dow,” Bianco said.
However, while the two banks have small market caps, their fate is key to the overall economy and therefore stock prices, countered David Joy, chief market strategist at RiverSource investments.
“Symbolically what happens with them has a lot of important implications for the broader economy,” Joy said.
Added Prestbo: “I read somewhere that GM is a metaphor for the U.S. economy because it’s in damn trouble.
“If a company is still big enough to be considered a metaphor for the U.S. economy, then wow.”
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Cheap stocks spark debate over Dow index’s utility
Deepa Seetharaman
23 February 2009
NEW YORK (Reuters) – There was a time when a tumble below $10 in the share price of a company in the Dow Jones industrial average meant ignominy.
Now, after vertiginous stock market falls in recent months, five of the venerable index’s 30 components are trading under that price, including its two oldest members, conglomerate General Electric and automaker General Motors.
Citigroup stock plunged below $2 on Friday, making it cheaper than a medium cup of coffee at Starbucks.
Continued membership in the Dow of these battered stocks, which include aluminum producer Alcoa and Bank of America, is raising questions over whether the index should overhaul its lineup to include the likes of bank Goldman Sachs or Internet company Google.
It has also stoked a decades-old debate over whether the 112-year-old index is really an accurate snapshot of the overall U.S. economy.
“It’s been out of touch for a while,” said Jocelynn Drake, an equities analyst at Schaeffer’s Investment Research.
“There are companies out there that are more significant to the market and they have not appeared in the Dow and there are others that should have been kicked out.”
But expelling stocks because they are cheap would fail “to tell the story of the U.S. economy,” said John Prestbo, editor and executive director of the Dow Jones Indexes.
“Companies that have sunk so far down we’ve kept because they were still telling the story of the financial industry,” said Prestbo, who helps select the companies in the Dow.
He declined to comment on the possibility of an index makeover but did not rule out the idea.
ELITE GROUP FACES CHANGE
Financial journalist Charles Dow created the index in 1896 to help investors track market trends in the absence of other metrics. Most investors, however, now use broader indexes such as the S&P 500 to follow stocks.
Still, the Dow is the most widely watched measure of the U.S. stock market and its members are considered an elite fraternity representing the best names in corporate America.
The index is rarely altered but when it is, it is done so at the discretion of a team of editors at The Wall Street Journal. Changes in its makeup affect funds such as Diamonds Trust, an exchange traded fund that mirrors the Dow.
It was last changed in September when food company Kraft Foods replaced American International Group after the U.S. government took a large stake in the insurer.
Now as shares of Bank of America and Citigroup plumb fresh lows, criticism is growing that the Dow has lost its luster.
“I was surprised Citigroup was still a part of it,” analyst Drake said. “GM is another one. I understand them trying to get a slice of the automotive sector but ... it’s not a market mover anymore.”
Drake added that Google and computer giant Apple are more influential in the stock market.
Citigroup and Bank of America should be swapped for a financial company with a higher share price, such as insurer The Travelers Co or Goldman, said James Bianco, chief executive officer of Bianco Research Securities.
This would paint a more accurate picture of the financial sector because the Dow is a price-weighted index, where cheaper stocks count for less. For every $1 lost on a Dow component’s stock price, the index sheds roughly 8 points.
That means if the three current cheapest stocks -- Citigroup, Bank of America and GM -- shrank to zero, the Dow would lose less than 60 points or 0.8 percent based on Friday’s close, a sign of how much the sector has declined.
“The financials have a much larger bearing on the market than is reflected in the Dow,” Bianco said.
However, while the two banks have small market caps, their fate is key to the overall economy and therefore stock prices, countered David Joy, chief market strategist at RiverSource investments.
“Symbolically what happens with them has a lot of important implications for the broader economy,” Joy said.
Added Prestbo: “I read somewhere that GM is a metaphor for the U.S. economy because it’s in damn trouble.
“If a company is still big enough to be considered a metaphor for the U.S. economy, then wow.”
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