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The Real Reason the Dow's Price-Weighted Model Broke Down

By Dan Caplinger – Updated Mar 7, 2017 at 4:09PM

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When IBM, Chevron, 3M stopped doing stock splits when their share prices rose too high, it made the Dow's price-weighting methodology a bigger problem.

Most investors understand that the Dow Jones Industrial Average (^DJI 0.01%) is a price-weighted index, making it unusual among market benchmarks. But after serving the Dow well for decades, the price-weighting model has started to create bigger problems. What's behind the change?

In the following video, Motley Fool Director of Investment Planning Dan Caplinger takes a closer look at the Dow's price-weighted model with an eye toward identifying why it has become more of a problem lately. Dan points out that in the past, the index's high-priced stocks conducted stock splits to keep their share prices down, reducing their relative influence in the average. But in the past decade, that trend has changed. IBM (IBM 0.21%), which was the most heavily weighted Dow stock until the index's component shift earlier this week, hasn't split its stock since 1999. Chevron (CVX 1.50%), which also has a high share price, hasn't split stocks since 2004, while 3M has gone a full decade without a split despite its triple-digit price.

Dan examines the reasons why stock splits have fallen out of fashion, noting the rise of exchange-traded funds and online brokers that have largely made the traditional 100-share round lot a thing of the past. He notes that high-priced new Dow entrants Goldman Sachs (GS 0.35%) and Visa (V -1.04%) have never done a stock split -- and neither seems to have any intention of doing so in the future. Yet unless they and other high-priced stocks execute splits, the Dow will continue to have big disparities in weighting among its components.

Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends 3M, Chevron, Goldman Sachs, and Visa. The Motley Fool owns shares of IBM and Visa. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$33,852.53 (0.01%) $3.07
Goldman Sachs Stock Quote
Goldman Sachs
GS
$383.71 (0.35%) $1.35
IBM Stock Quote
IBM
IBM
$146.49 (0.21%) $0.31
Chevron Stock Quote
Chevron
CVX
$181.03 (1.50%) $2.67
Visa Stock Quote
Visa
V
$209.06 (-1.04%) $-2.20

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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