Goldman and Visa Vault to the Top of the Dow

Goldman and Visa Vault to the Top of the Dow

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Another solid opening for stocks this morning, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average up 0.58% and 0.6%, respectively, as of 10:10 a.m. EDT.

Dow: Goldman and Visa go straight to the podium!
A big change is underway in the markets! S&P Dow Jones Indices has announced that it is changing the lineup in its Dow Jones Industrial Average, arguably the most widely known (though not the most widely tracked) stock market index in the world -- and they're not going at it with kid gloves. Being added are Goldman Sachs , Nike, and Visa, which will replace Bank of America , Hewlett-Packard and Alcoa. This is the first 3-for-3 switch in nearly a decade (the last took place on April 8, 2004).

You may well ask who makes these decisions. A computer model? Ben Bernanke? The vampire squid itself, Goldman Sachs? In fact, it's three people that make up what is known as the Averages Committee: the managing editor of The Wall Street Journal, the head of Dow Jones Indices research and the head of CME Group research. The Averages Committee also maintains the Dow Jones Transportation and Utilities averages.

On what criteria does the committee rejigger the index? This is how S&P Dow Jones describes its process for picking stocks:

Generally, composition changes occur only after mergers, corporate acquisitions or other dramatic shifts in a component's core business. When such an event necessitates that one component be replaced, the entire index is reviewed. As a result, when changes are made they typically involve more than one component.

While there are no rules for component selection, a stock typically is added only if it has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors and accurately represents the sector(s) covered by the average.

Unlike the DJTA and DJUA, which include only transportation and utilities stocks, the DJIA is not limited to traditionally defined industrial stocks. Instead, the index serves as a measure of the entire U.S. market, covering such diverse industries as financial services, technology, retail, entertainment and consumer goods.

How will these changes affect the six stocks in terms of money flows and stock price? Very little, I suspect. Price-weighted and containing just 30 stocks, the Dow is a relic of history. As such, the amount of money that is indexed or benchmarked on the Dow is insignificant relative to the S&P 500, for example.

On the other hand, these are significant changes for the index; indeed, because the Dow is price-weighted, Goldman and Visa will automatically become two of the three largest components in the Dow, alongside IBM.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on LinkedIn. The Motley Fool recommends Bank of America and Goldman Sachs. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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