At the beginning of last week, the committee that oversees the Dow Jones Industrial Average (DJINDICES: ^DJI ) announced that Bank of America (NYSE: BAC ) will be replaced on the index by Goldman Sachs (NYSE: GS ) on September 20 -- this Friday, that is.
The committee explained the decision by saying that the changes "were prompted by the low stock price of the three companies slated for removal and the Index Committee's desire to diversify the sector and industry group representation of the Index."
But here's the catch: Bank of America and Goldman Sachs are in the same industry. As a result, if the powers that be were really interested in diversifying the "sector and industry group representation of the index," then why didn't they replace Bank of America with, say, Amazon.com?
This issue came up at an industry conference last week. As an analyst noted during a session involving Bank of America's CFO:
I was disappointed to read that your company is going to be dropped from the Dow Jones in a few weeks. I don't understand that. Did they give you an explanation? Because you have a much more broad-based effect on the economy. You deal with retail, wholesale, government, as opposed to a Goldman which is a niche institution, primarily institutional, not retail, more -- perhaps more volatility depending on their investment banking. You're much more diversified.
The bank's official response to the move offered little insight. "This decision has no impact on our business or our strategy for providing solid returns to shareholders," the company said in a statement following the announcement.
Given this, is it possible that the index committee simply preferred Goldman Sachs over Bank of America? Or, as my colleague Amanda Alix opined over the weekend, did it have something to do with the latter's tarnished reputation?
The genuine reason, it turns out, is probably much less nefarious. And in fact, despite the conspiratorial insinuations that accompany any conversation involving Goldman Sachs, the index committee's original explanation, while perhaps curt, is probably right on point.
Here's how Bank of America's CFO explained it in response to the analyst's statement above:
[I]f you look at the way that the Dow is weighted, because it's based on a stock price as opposed to a market cap, our sense ... is that there was a desire to get a heavier weighting of financials into the index, which by taking a company that has a higher stock price than where ours is, it accomplishes that.
In other words, even though Bank of America and Goldman Sachs are both financial companies, exchanging the latter for the former would have a big impact on the index's weighting, because Goldman trades for $167.42 a share while Bank of America's stock is priced at a comparatively measly $14.55.
Lest there be any doubt: With Bank of America, the financial sector accounts for 11.35% of the Dow's daily moves. With Goldman, at today's prices and holding all else equal, it will have a weighting of 17.58%.
With this in mind, if you're a Bank of America shareholder, there's really no reason to be concerned that it was booted off the index for something bad that it's done -- though, there's certainly plenty of that to go around as well.
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