Transcription: Segment 4
Paul Winkler: You are listening to the Investor Coaching Show, Paul Winkler here, along with Evan Barnard and Arlene Brown. So a couple things there, as you know, you guys noticed that the Dow changed. Yes. Big change, big change in the Dow coming up. I said, this is interesting. A little history on that Krispy Kreme. No, but they did kick out ExxonMobil.
Arlene Brown: That’s really sad because that’s since 1928, they have been in there.
Changes to the Dow and the S&P 500
Paul: Well, but you know, this is the thing about individual stocks. And we always talk about, you know, the average amount of time for them. This is why we don’t buy individual stocks because companies are coming and going much more rapidly today. And companies, you never thought would go away. Oh, Apple, that’s the company. That’s going to save my life and save my retirement and take care of me forever. Oh, Amazon, that’s going to be the company that saved my life and saved my retirement, Microsoft, you know, I, and the reality of it was, that’s what people said about GE, ExxonMobil, Raytheon. It was all Pfizer and Pfizer.
It’s interesting because they’ve had some good news recently and they’re going to be out. Salesforce is one of the replacements. Kidding me. I am not joking. That surprised me as well. And Amgen and Honeywell. Now, this is interesting because it’s the criteria for how companies work. So you’ve heard me talk about, I hate it. I hate it. I hate it. Hate it. They’re always talking about the Dow and the S&P 500. It drives me nuts because to the media, that’s all the stock market is the Dow 30 companies and the S&P 500 companies, but dominated just massively dominated by just six names and fairly well dominated by two names.
You know, like 10% of the index is just two companies, which is just insane. But here’s, what’s interesting is the Dow has 30 companies. And you look at this, and this is a biggest major change since you know, Walgreens. You remember when Walgreens kicked out, kicked out well in 2018 is when they kicked out GE a couple of years ago when that happened. Cause I remember it really well because my family had a close connection with GE.
Eligibility requirements
So this is the S&P 500. If you look at the eligibility requirements for the S&P 500, there’s a long list of requirements to get in the S&P 500, but the Dow doesn’t have that many rules. I’d seen the rules and I thought it was fascinating to see what they were, they have to be considered for the Dow. A stock must be a non-transportation or non-utility company in the S&P 500.
I thought that was interesting. I don’t know where that comes from. Dow is not governed by quantitative rules, right? It’s you know, it says a stock is typically added only if the company has an excellent reputation, demonstrates sustained growth, and is of large interest to a large number of investors, which I thought was fascinating because if we look at the history of the Dow stocks, and we look at the Dow industrial average, the rate of return, isn’t all that impressive.
Now, it’s been good recently. And, you know, because bigger companies and bigger companies have dominated in recent years. But if you look at the history, it hasn’t been all that impressive. And this is good, this goes a long way in explaining why that’s the case. And the reason being is what was the criteria for the company to get in there. It’s of interest to a large number of investors. When do investors, Evan, and Arlene, get interested in opening up in value, significantly, exactly acting after it has gone up.
And when do people actually start to pay attention to stuff? After it’s gone up in value, after good news comes out about companies. Now, what happens when a company is actually added to a major index, like the Dow, the stock price goes up. Why? Because it draws even more attention. And anybody that runs a doubt index fund, a fund that actually tracks the Dow has to now buy this stock in large quantities, driving up the demand for the stock, driving up the price of the stock.
And then for the companies that are going to be replaced, they get the opposite treatment. They actually see a significant decline in value because of the fact that any time anybody runs an index fund is going to get rid of those companies. And maybe there’s some stigma as well. Oh, my company got dropped out of the Dow. Oh, let’s get, you know, and then they get rid of the stock, they sell it off and then it drops even further. And it might be, they might be feeling pretty good though. Cause it’s like, you’re, you know, the president of the company says, he’s not going to visit your division for another 10 years.
You’re like, great. I don’t have the entire world looking at my every move. I see that for just half of it, earnings might be breathing a sigh of relief. You don’t even want one through my mind when you said that he might be happy is, is the oldest, the oldest adage that says, I don’t want to be a member of a group that’ll have, so I want to stop.
Evan Barnard: They constructed the Dow to be representative of the American cross section of business and is sort of, you know, but it, you know, they replaced Raytheon. They were replaced with Moodle. What’d you? What was that? Industrial Honeywell. Yeah.
Paul: So, so you did have, you know, a pharmaceutical and a pharmaceutical out.
Manipulation of the market
Arlene: Yes. I thought that reason was because of, to diversify a little bit of diversity for no redundancy between.
Then, because as well, those that were kicked out were in $40, $50 price, and now they are being changed to replaced by companies that are in $200.
Paul: Yeah. Which makes it really interesting because now you have to, you have to change the multiplier. And you know, when you do that, because in what Arlene’s basically talking about, folks is this is when a stock in the Dow is being removed. Let’s say that let’s just keep the math really, really simple. Let’s say that the price of the stock is $10 and it’s going to be replaced by a company that’s selling for $20. Well, if I go and just replace the stock and throw that $20 stock in there, we’ve got a $10 bump in the index, right?
Like that. But there was no market movement that caused it. So to not have that happen, what they do is they from now on, when they calculate what the Dow closes at, they multiply the new stock by 0.5. So by multiplying 0.5 by 20 becomes 10. So it’s 10 replaced by 10. So it doesn’t have that impact. So, you know, that’s how they have to do that. So it makes it really, really interesting just in that the company’s, you know, going in now, what causes that to happen and just think about it.
Would you like personal help with your financial plan? Schedule a call with us to explore what this can look like for you here.
Or schedule a more in-depth, virtual or in-person meeting here.
Companies don’t last forever
You know, when you have an individual stock portfolio as an individual stock investor, you’re buying companies that you think are going to be around forever. And the reality of it is companies don’t last forever. It’s a very competitive world. You know, new companies will find ways to out compete and all your information is on the internet. You run a company, all your information is out there. People can find out exactly what you’re doing and they can find ways to mimic it. If you’ve got, let’s say a good process and people like it, everybody knows how much they like it because the information is broadcast everywhere.
What your sales numbers are instantaneously. I mean, it doesn’t take any time for information to travel anymore, like it used to. And that is why it is imperative. Just broad diversification is very, very important, simply just because the world is a different world. But you know, what’s interesting is individual stocks are, one study showed that individual stocks are far, far more volatile today than they were in decades past; they’re far more volatile, but the market itself is not more volatile.
Just stew on that for a second. What does that mean? A company stock and individual stock has much more up and down. So you have a greater likelihood of losing your money, and you might have something that takes off and does very, very well. And it’s just a gamble. Whereas the overall market is no more volatile. And why is that? It is because they found in the study that companies seem to be offsetting. Each other one company goes away. Another one takes this place and they offset each other.
So that keeps the volatility of the market within historic norms. So when you hear that, Oh, the market’s just really, really volatile. It’s a gambling casino, unknown, no more than it’s ever been. It’s been the greatest wealth creation tool known to mankind historically. And that is why we always talk about it in America. We talk about investing in the stock market. Why, because you get to own companies who are the most successful people in the world, company owners. And what do you get to be when you invest in the stock market, you get to be one of those people that own a company.
And it’s a, it’s a good thing. So it’s very, very interesting to see the changes that are taking place. I’ll tell you what, let’s take a quick break and we’ll come back right after this. You’re listening to the Investor Coaching Show.
Want to talk with us directly?
Schedule a call here.
Ready to meet with us virtually or in person? Schedule a meeting here.
*Advisory services offered through Paul Winkler, Inc. (‘PWI’), a Registered Investment Advisor. PWI does not provide tax or legal advice: please consult your tax or legal advisor regarding your particular situation. This information is provided for informational purposes only and should not be construed to be a solicitation for the purchase or sale of any securities. Information we provide on our website, and in our publications and social media, does not constitute a solicitation or offer to sell securities or investment advisory services, or a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.
