Most investors understand that the Dow Jones Industrial Average (DJINDICES:^DJI) 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 (NYSE:IBM), 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 (NYSE:CVX), 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 (NYSE:GS) and Visa (NYSE:V) 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.