The Dow Jones Industrial Average is one of the America’s oldest stock indexes, and it’s easily the country’s most iconic. It’s comprised of 30 huge multinational corporations, all of which have demonstrated a penchant for creating shareholder value over the long run.
The Dow’s fatal flaw
However, this popular index also has a pretty sizable shortcoming that some investors tend to overlook. Unlike the broad-based S&P 500, which moves up and down based on the share-price movements of its roughly 500 companies and their respective market-cap weightings, the Dow Jones is a purely point-based index. This means that companies with a higher share price have more influence on the Dow than those with a lower share price, regardless of market cap.
For example, conglomerate General Electric is the sixth-largest company represented in the Dow, with a market cap of roughly $260 billion. But its share price is less than $30. Based on the current Dow divisor, which translates the share prices of Dow components into the point value that we follow as investors, GE’s share price contributes just 202 of the Dow’s 20,548 points, the closing value as of Friday, April 21. That’s not even a full 1%. Yet, a company we’ll be discussing in a moment that has just 30% of the market cap of GE also has seven times its influence in the Dow, all because of share price.
In fact, through Friday, the Dow would be 308 points higher if the following three companies were merely flat for the year instead of down between 9% and 11%.
Goldman Sachs — 154.70 year-to-date Dow points
Though it doesn’t happen often, Goldman Sachs missed Wall Street’s expectations by a wide margin in the first quarter, and that’s the primary reason it’s shaved nearly 155 points off the Dow year to date. It’s also the company that has seven times as much influence on the Dow as GE based solely on its share price.
For the first quarter, Goldman wound up reporting $5.15 per share in EPS on $8.03 billion in revenue. Comparatively, Wall Street was looking for $420 million more in revenue and $0.16 more in earnings per share. Goldman attributed its subpar results to weakness in certain market segments. For instance, even though investment banking revenue scorched higher by 16% year over year, revenue from fixed income was flat, while equity revenue dipped 6% on account of weaker volumes in the United States.
The low interest rate environment continues to hold back Goldman Sachs, which is listed as a bank in name, but is really an investment institution by practice. The good news is that at least the Federal Reserve is in the midst of tightening monetary policy, albeit slowly. As rates rise, investor demand for fixed-income assets will likely improve as well. This should reduce market volatility and give the king of bonds, Goldman Sachs, some healthy profits.
But it’s going to take time before the bond market is a boon once again for Goldman Sachs. In the interim, it’s been quite the drag on the Dow in 2017.
Chevron — 87.72 year-to-date Dow points
Integrated oil and gas companies have regularly taken it on the chin over the past three years. Surprisingly, though, Chevron has held up better than many of its peers. Its geographic diversity and ability to cut costs probably played a key role in its ability to withstand sinking crude oil prices.
However, in 2017 Chevron has been notably weaker. On a pure percentage basis, Chevron is the worst-performing stock in the Dow year to date, and it’s removed almost 88 Dow points. The failure of crude prices to move higher is one reason Chevron is struggling. Despite cuts from OPEC that were expected to reduce supply and help buoy crude prices, U.S. crude and gasoline inventories hit an all-time record high in mid-February. This picture paints the need for more production cuts in the future, and more importantly, shows there is no quick fix for crude oil prices.
The other issue for Chevron is that its fourth-quarter earnings results, released earlier this year, weren’t very encouraging. Despite the company’s $415 million in net income during Q4 2016, there were a handful of disappointments. For instance, Chevron’s operating cash flow is still not high enough to cover the costs of paying out its dividend. Chevron has admittedly worked hard to become a Dividend Aristocrat (i.e., a company that’s increased its payout for 25 or more consecutive years) and likely doesn’t want to give up that title, but it’s being forced to issue debt to cover a portion of its payouts at the moment.