For nearly 126 years, the Dow Jones Industrial Average (^DJI -0.11%) has been a closely followed index that investors have used to evaluate the health of the stock market. Initially comprised of just 12 stocks during its May 1896 debut, the Dow Jones is now home to 30 highly profitable and mature multinational companies.
Since 1896, there have been more than 50 changes to the components of the Dow Jones Industrial Average. Sometimes mergers and acquisitions have necessitated a reshuffling, whereas other instances involved removing companies that were no longer pillars within their industry or representative of the overall U.S. economy.
In the not-so-distant future, another Dow Jones reshuffle may be coming.
Image source: Getty Images.
Tesla charges forward with another stock split
Roughly three weeks ago, electric vehicle (EV) manufacturer Tesla (TSLA 12.06%) announced its board of directors had approved a proposal that would allow the company to split its stock. Shareholders are expected to vote to approve or deny this split at the company's next annual shareholder meeting. For context, Tesla's shareholder meetings have been held in June (2019), September (2020), and October (2021), over the past three years, and the company has yet to set a date for its 2022 annual meeting.
Although a stock split is nothing more than a way for a publicly traded company to alter its share price and outstanding share count without affecting its operating performance or market cap, Tesla's shares have vaulted higher before on a stock split announcement.
In August 2020, Tesla's shares gained in excess of 60% in the 20 days between announcing a 5-for-1 split of its shares and the split taking effect. Companies usually split their shares after a significant run-up, which is often an indication that a company is executing on its strategy and out-innovating its competition.
While it's unknown how large of a stock split Tesla and its board have in mind, another 5-for-1 split would hypothetically lower the EV makers' share price to about $205. It would also make Tesla a possible target for inclusion in the Dow Jones Industrial Average.
A Tesla Model S charging. Image source: Tesla.
Here's why Tesla would make sense in the Dow
Despite its popularity, the Dow has a pretty big flaw: it's a price-weighted index. This means a company's share price, not its market cap, determines its weighting within the index. With a current share price of more than $1,000, Tesla would soak up far too large a weighting to be added to the Dow. But following a proposed stock split, adding Tesla might make a lot of sense.
For instance, it's been nearly 13 years since the Dow Jones last had an automaker represented in the index. General Motors was given an unceremonious heave-ho on June 8, 2009. Prior to this, GM had been a fixture in the Dow since August 1925. Even though automakers aren't the economic pillars of the industrial sector that they once were, the shift to green-energy solutions (i.e., EVs) should provide a multidecade shot in the arm of organic growth for the auto industry.
Furthermore, Tesla is more than just an automaker. In addition to controlling the lion's share of the U.S. EV market, Tesla's energy subsidiary manufactures, sells, and installs solar panels, as well as provides integrated battery systems to store solar energy. Since the current 30 Dow components are light on energy sector representation, adding Tesla would make the index a bit more diverse.
Tesla's track record is another key selling point. Since the Dow is driven by share price increases, Tesla's more than 15,000% gain over the trailing decade, and nearly 1,600% increase over the trailing five years, stand out as an attractive lure.
Lastly, it's the fifth-largest publicly traded company by market cap in the United States. It's not far-fetched to think a company with a $1.06 trillion market cap would be added to what's arguably the most-followed stock index in the world.
Image source: Getty Images.
Hit the brakes: Tesla joining the Dow may be unlikely
But there's another side to this story.
Although it's impossible to rule out Tesla joining the Dow -- especially without knowing how large of a stock split the company intends to execute -- there are also plenty of reasons to suggest it won't be a Dow component anytime soon, if ever.
Perhaps the biggest hurdle for Tesla is that Alphabet (GOOGL 0.55%) (GOOG 0.74%) and Amazon (AMZN -1.64%) beat it to the punch in declaring stock splits. Alphabet, the company behind internet search engine Google and streaming platform YouTube, and e-commerce giant Amazon, both recently announced their plans to enact 20-for-1 stock splits. If approved by shareholders, Alphabet's split would take effect in mid-July, while Amazon's would occur in early June.
The issue is that the argument for including Alphabet and/or Amazon in the Dow is far stronger than the case that can be made for Tesla. Alphabet is the leading global internet search giant, it owns the second most-visited social site on the planet (YouTube), and its cloud infrastructure segment (Google Cloud) is No. 3 in global share. Meanwhile, Amazon controlled an estimated 41.4% of online sales in the U.S. last year (more than 34 percentage points higher than the next-closest competitor), and its cloud infrastructure segment (Amazon Web Services) is No. 1 in global share.
The Dow is also known for including profitable and established businesses. Though Tesla is profitable, it only recently began generating profits from the sale of its EVs. In previous years, the company had relied on renewable energy credits to push the needle into the profit column.
Another concern is Tesla's share-price volatility. While chasing Tesla's high-flying returns might be alluring, the wild swings Tesla's shares are prone to don't fit with what investors are used to seeing from Wall Street's flagship stock index.
Again, I can't rule out that Tesla won't be added to the Dow Jones Industrial Average following its stock split; but I see the chance of this occurring as pretty low with Alphabet and Amazon being the more likely entrants.
