Concentrated exposure to U.S. industry leaders

The Dow Jones Industrial Average has an odd weighting scheme that limits its appeal.

Alex Bryan 10 August, 2016 | 5:00PM

The Dow Jones Industrial Average is an index made up of 30 industry-leading companies that approximate the industry composition of the U.S. stock market, excluding stocks in the utilities and transportation industries. A committee selects stocks for the index on the basis of subjective factors, including the strength of each firm's reputation, industry leadership, investor interest and a history of successful growth.

Since its inception in 1896, the Dow has served as a barometer of the U.S. stock market by tracking a select group of the country's industrial leaders. Unlike most indexes, the Dow weights its constituents by their share price, rather than by market capitalization. So, even though  Exxon Mobil (XOM) has a larger market cap than  Goldman Sachs (GS), it receives a lower weighting in the portfolio because its share price -- about US$87.50 at the time of this writing -- is lower than that of Goldman Sachs at US$162.

Price weighting is a relic from the 19th century that was adopted because other weighting options, such as market-cap weighting, were impractical before computers were introduced. This simple price-averaging approach, which gives higher-priced stocks larger portfolio weightings, does not have a sound economic basis. Price weighting also may limit the index committee's selection options. For example, thanks to  Alphabet's (GOOG) high stock price, it would account for more than 20% of the index if it were included, which could distort the Dow's representation of the U.S. market.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
3M Co176.89 USD-0.13
Alphabet Inc Class C1,793.19 USD1.23
Apple Inc116.59 USD0.48
AT&T Inc29.03 USD0.14
Exxon Mobil Corp40.19 USD-1.52
Goldman Sachs Group Inc235.40 USD-0.48
International Business Machines Corp124.35 USD0.12
Verizon Communications Inc60.58 USD0.28
Visa Inc Class A211.00 USD0.05

About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA, is director of passive strategies for North America at Morningstar. Before assuming his current role in 2016, he spent four years as an analyst covering equity strategies. He holds an MBA with high honors from the University of Chicago Booth School of Business.

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