It was announced this morning that three companies – Bank of America, Hewlett-Packard, and Alcoa – will be dropped from the Dow Jones Industrial Average this coming Friday after the market closes. In their place will be Visa, Goldman Sachs, and Nike.
Alcoa was one of the oldest components of the Dow, having joined in 1959. During its tenure, its former Chairman and CEO Paul O'Neill went on to become Treasury Secretary. However, Alcoa has been the worst performing Dow stock so far this year. Hewlett-Packard had that title in 2012 but is up 54% in 2013. Bank of America, which fell in price by 71.5% the first year it joined the index (in 2008), is up 25% this year.
The Dow is a price-weighted index, meaning each company's contribution to the index is based on its stock price. By contrast, the S&P 500 Index – made up of the 500 largest US companies – has each company's weight in the index determined by market cap. It is for this reason that the S&P 500 is thought of as "the market" by much of Wall Street, though the Dow is most followed by popular media.
Because of the price-weighted nature of the Dow, the three new components will now represent 17.39% of the index. The ousted three companies were 2.29% of the index combined. Each of the remaining 27 companies will see their weights diminish to compensate for the difference.
One interesting feature of the new weights is that the volatility of the index will be less than before. According to researchers at Birinyi Associates, a $1 move in any Dow's components used to move the index by 7.68 points. After the change, the index will move 6.49 points on any component's $1 price change.
The last time three stocks were added at once to the Dow was in 2004, when AIG, Pfizer, and Verizon joined the index. Within a year, all three stocks were down an average of 21% (AIG dropped nearly 32%). Since 2004, stocks added to the Dow fall about 10% on average the first year they are added to the index.
With Visa up 20.5% and with Goldman Sachs and Nike both up 29.1% in 2013, which of these three new Dow components might buck the average trend and have a good year?
We get answers to that question from CNBC contributor Gina Sanchez, founder of Chantico Global. To see if the charts agree with Sanchez's assessment, Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson, looks at the technicals.
To see what new Dow component Sanchez and Ross think is a buy, watch the video above.