They say in acting, "There are no small parts, only small actors." Not so with indexing. Take the Dow Jones Industrial Average (DJINDICES: ^DJI), for example. Given that it's the most recognized stock index in the world, the Dow's value ebbs and flows with the market but is heavily influenced by a few big actors.
Intrigued by which blue chips played the largest role in pushing the Dow to 16,000 during the past year, I diagrammed the components using the chart maker Infogram. Below is a graphic representation of the 30 companies that make up the average today. (Hover your mouse over the chart for the exact percentage weight of each company.)
As shown, one of the newest members of the Dow, Visa (NYSE:V), is also the largest, making up 8.77% of the index's value. The credit card company was added to the index on Sept. 23, 2013, alongside Nike and Goldman Sachs.
Despite its lack of tenure, Visa shot straight to the top of the index solely due to its hefty stock price of $198 per share in September. Visa, which held an admittedly modest influence on the S&P 500 index the day prior, surpassed the long-standing leader of the Dow, IBM (NYSE:IBM), to become the most influential stock in the most-watched index in the world. Talk about an overnight sensation.
Now, this whole process might sound a bit absurd, especially in the highly sophisticated world of finance. Logically, why would a stock's price account for its influence on the Dow? You can't help but wonder if the Dow editors would choose the Oscars based on movie budgets or some other arbitrary figure.
Of course, this point has been raised numerous times. And, as my colleague Will Chavey pointed out, the index appears to serve its purpose: "To provide a clear, straightforward view of the stock market and, by extension, the U.S. economy." Regardless of their differing methodologies, the S&P and the Dow move in a near-lockstep over time.
I also must note that Visa's position atop the Dow is not undeserved. The company was one of the top-performing stocks on the blue-chip index during a strong year for the overall market, while IBM was the worst. Furthermore, financial stocks weigh heavily on the Dow's movements. Visa, Goldman Sachs, and American Express combined account for 19% of the index's value.
For the full perspective, the following chart shows how the top five and bottom five performers measure up in terms of weight and returns over the past year.
While it seems odd to admit that some companies simply matter more than others on the Dow, that's the way the cookie crumbles. And the effect is highly dramatic.
For instance, the Dow's website states, "Roughly two-thirds of the DJIA's 30 component companies are manufacturers of industrial and consumer goods." But in reality, the industrials and consumer goods stocks make up only 41% of the weight of the index -- a discrepancy of more than 25 percent.
As the second-oldest U.S. market index, though, the Dow won't change anytime soon. The Dow editors appear to be firm believers in the "if it ain't broke, don't fix it" philosophy. Not only has the index been a constant in a market that's ever-changing, but it's "understandable to most people, and it reliably indicates the market's basic trend," according to Dow.
For investors, the Dow will remain a significant barometer of the markets. It might not be the fine-tuned instrument you imagined, but armed with the above information, you should be well equipped to read between the headlines.