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The DJIA's Dangerous Indexing Philosophy

Nov 04, 2009 - 6:01 AM EST

While doing some research on the Dow Jones Industrial Average, I was disappointed to discover how skewed it is toward just a few of its components and how dangerous it is for the world to use it as a benchmark for the American markets. The DJIA is a price weighted index, which simply means that the weighting of the index is based on the price of each component. By price I do not mean Market Capitalization but I mean the actual price it is trading at. Please look at the table below to see what I mean:

Dow Jones Industrial Average Components
STOCK	% WEIGHTING	PRICE
IBM	9.31	$120.56
Chevron	5.92	$ 76.64
3M	5.73	$ 74.28
ExxonMobil	5.57	$ 72.15
United Technologies	4.84	$ 62.66
Johnson & Johnson	4.59	$ 59.49
McDonalds	4.57	$ 59.16
Procter & Gamble	4.55	$ 58.95
Caterpillar	4.28	$ 55.49
Coca-Cola	4.15	$ 53.72
Wal Mart	3.88	$ 50.28
Travelers	3.88	$ 50.20
Boeing	3.73	$ 48.27
Hewlett Packard	3.72	$ 48.16
JPMorgan Chase	3.29	$ 42.58
American Express	2.75	$ 35.68
Dupont	2.49	$ 32.27
Merck	2.41	$ 31.26
Verizon Communications	2.27	$ 29.41
Microsoft	2.15	$ 27.88
Kraft Foods	2.13	$ 27.64
Disney	2.12	$ 27.41
AT&T	1.98	$ 25.59
Home Depot	1.93	$ 25.06
Cisco Systems	1.78	$ 23.00
Intel	1.47	$ 19.01
Pfizer	1.31	$ 16.95
Bank of America	1.13	$ 14.63
General Electric	1.12	$ 14.47
Alcoa	0.96	$ 12.48

As you can see from the table above, the top 10 companies on the list represent 53.51% of the Index , so for example if all those 10 companies have a terrible day and the rest of the 20 have a decent day, the DJIA Index will still show a large loss.

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Source: Seeking Alpha (Nov 04, 2009 - 6:01 AM EST)