When the Dow Jones Industrial Average (DJINDICES:^DJI) got a makeover last month, the index played strange games in the financial sector. Bank of America (NYSE:BAC) is the third-largest American bank by market capitalization, but it still got the boot from the Dow. Goldman Sachs (NYSE:GS) took B of A's seat, passing over two much larger domestic banks in the process.
Was that the right decision, or did the Dow botch its largest makeover in nearly a decade?
First, let me say that Bank of America probably deserved the boot. Sure, Bank of America's stock is bouncing back from the doldrums of 2008-2009, but the recovery is a day late and a dollar short.
The Dow is weighted by share prices, and Bank of America is still a minnow by that measure. This stock's daily price moves were highly unlikely to affect the Dow's value in any meaningful way, while replacement Goldman swings one of the index's heaviest bats.
So, this move fits with the Dow's official reasoning behind the shakeup: "The index 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."
Fair enough. But why did the committee choose Goldman Sachs, when both Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) stand outside the Dow, looking in? Here's how these bank stocks compare on a few important metrics:
Goldman's market cap is half of Bank of America's or Citigroup's and one-third of Wells Fargo's. Still, $73 billion is nothing to sneeze at, and it's perfectly in line with many other Dow members -- but it's also not enough to print a guaranteed membership ticket. By this metric, you'd expect Wells Fargo to get the nod long before the Dow's selection committee even considered Goldman.
But like I said, Goldman's share price is among the largest on the Dow today. Neither Wells Fargo nor Citigroup can put up much of a fight here. And because the makeover was directly prompted by share price concerns, Goldman suddenly makes perfect sense.
The company's fantastic revenue growth also stands out from the other big banks, driven by a huge increase in trading fees. Goldman's trailing trading transactions doubled over the last year. Citigroup can't make that claim. Wells Fargo can, but trading fees make up just 2% of the bank's total sales, so it's no game changer. The Dow may have looked at the basic health of prospective members, and Goldman's strong sales growth would certainly have worked in its favor here.
All things considered, I'd still be happier to see Wells Fargo on the Dow than the Goldman situation we have now. Don't get me wrong -- Goldman Sachs is a very respectable company with all the right numbers to place it on the Dow, but Wells Fargo comes with even higher-quality management and a larger-scale operation overall.