For the first time in four years, the Dow Jones industrial average is changing its stocks to beef up its weighting in financials and oil and cut back on industrials. It's dropping Altria and Honeywell International, replacing them with Bank of America and Chevron before the market open Feb. 19.
"The increased allocation to financials and energy should tilt the index toward a higher correlation with the S&P 500, where those two sectors combine for approximately 30% of that index," said Greg Allison, an analyst with RegentAtlantic Capital. "Bank of America and Chevron also carry lower P-E ratios than the two companies they replace, which will reduce the overall P-E of the index."
Food and tobacco giant Altria sparked the need for change in the 111-year-old, 30-stock benchmark. Last year, Altria spun off Kraft Foods (NYSE:KFT - News). Next month, it intends to spin off Philip Morris International. That would separate its domestic and foreign operations and make it a smaller and more narrowly focused company.
Industrial Changes
"When something is happening to a company like Altria, we take a look at all 30 stocks and review the whole works," said John Prestbo, executive editor of Dow Jones Indexes.
There are no predetermined criteria for a stock to be added or deleted, Prestbo said. But Dow Jones aims to include established companies that are the leaders in their fields. The Wall Street Journal's managing editor picks which companies are included in the world-renowned index, which accounts for about 25% of the market's value.
Honeywell is being replaced because it's the smallest in its category in terms of revenue and earnings.
According to Prestbo, "Industrials have gotten a little heavy, relative to the market as a whole, in the Dow, which is another way of saying the role of industrials has shrunk a bit in the past 10 to 20 years."
Representing The Street
Bank of America, worth $187 billion, is being added to counter the underweighting of financials.
"Financials are going through a bit of a rough patch," Prestbo said. "We believe this will pass, and meanwhile we want to take advantage of making a change to bring our financials representation up."
Chevron, which was deleted in 1999, is re-entering the mix to increase the index's weighting in oil.
"Oil was way underweighted," said Neil Hennessy, president of Hennessy Funds.
Dow Jones said it will adjust the calculations of the price-weighted index before Feb. 19 so that the replacements will not affect its level. The changes will not materially affect the performance of the index either, said Hennessy.
"You're just getting rid of two large companies and putting in two large companies," he said.
The index has been updated about once every two years since World War II.
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