Jun. 11th, 2009 10:56 am:
Cisco on the Dow

Last week, General Motors filed for Chapter 11 bankruptcy.

That same day, GM was delisted from the Dow Jones Industrial Average. It’s replacement – a company I'm all too familiar with – Cisco.

"Cisco makes the paving bricks for the information superhighway and it's affecting the culture in kind of the same way that automobiles affected the culture in the 20th century," John A. Prestbo, editor and executive director of Dow Jones Indexes, told The Associated Press. "We thought it was a fitting replacement for General Motors."
Yes – and no.

General Motors has been the #1 stock on the DJIA more often than any other company in the DJIA’s history, and it’s delisting is a sea change; an end of an era. And there’s something symbolic about the idea that America’s industrial future belongs not to petrolheads but to propellerheads. But let’s hold off judgment just yet. Cisco’s inclusion (though I'm awfully proud of them) might not have as much to do with what they do with what their stock price is at the current moment.
Nicholas Colas, chief market strategist for ConvergEx Group, in New York said Cisco was a logical choice not only because the company's business is an important one but because its shares aren't as high as some companies analysts speculated might have been added, like Apple Inc. or Google Inc.

The Dow is weighted by price so adding Apple and Google, which each have triple digit share prices, could have been more disruptive. Cisco at $19 won't have as much weight as IBM Corp. at $106. Google, at $417, would have vaulted to the most influential Dow stock. By comparison, Cisco will have roughly a 2 percent weighting.
Hold up for a second. Cisco’s great, but one of the reasons it’s been added is that the stock price is roughly numerically equal to the stock that it’s replacing? That seems odd to me. Don’t get me wrong – Cisco (Market Cap: $111.09B) is certainly worthy of being on the DJIA, but more worthy than Google (Market Cap: $134.81B) or Apple (Market Cap: $125.10B)?

I have no clue whatsoever what a market cap actually is, but that seems off to me.

So, what is the DJIA? Is it the best stocks? Is it the most average stocks? The biggest companies? The most average companies? Wikipedia points out that the Index is 30 stocks, originally 12 stocks selected by William Dow back in 1896 – but other than that, it’s hard to tell what makes a stock Dow-worthy and not. Of those stocks, only General Electric has retained its position on the list since 1896, so even the stocks change over time – which means that if you compare the Dow Jones of today to the Dow Jones of, say, November 5, 1955, you’re not comparing apples to apples.

So the question is – if it’s only 30 stocks, how the hell is that representative of the economy? And why does public opinion – and in many cases, the news media, rely on the DJIA as an indicator of the economy? “The Dow Is Up” is seen, more often than not, as “The Economy is Up,” but there’s really little, if any correlation between the state of the economy and the state of those 30 stocks; if a company stock price increases in a bad economy, and they’re on the Dow, the Dow goes up.

Ultimately, the Dow is used incorrectly as a way to measure the economy – or at least the stock market – when the only thing that the Dow accurately measures is the performance of the Dow. It’s simple, it’s easy to understand, and it’s wrong to confuse it with some sort of economic health indicator.

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