Walgreens: Vulnerable Component for Removal

Introduction

Walgreens' Struggles

Since its inclusion in the Dow Industrials in June 2018, Walgreens has experienced a significant decline in its stock value. With a staggering 65% decrease, Walgreens has been a disastrous addition to the index. This downward trend continued recently when the company decided to cut its dividend by 48% to 25 cents per quarter, causing a further decline in its stock price. Analysts and investors had anticipated this move by Walgreens.

Potential Changes to the Index

The possibility of changes to the Dow Industrials is looming, and two prominent contenders for admission are Google parent Alphabet and Amazon.com. Berkshire Hathaway and Tesla are also being considered as potential entrants. It is worth noting that the index hasn't seen any component changes in over three years.

Other Contenders for Removal

Apart from Walgreens, there are other companies that could potentially be removed from the index. These include Travelers, Verizon Communications, and Intel. However, S&P Dow Jones Indices, the organization responsible for the index, refrains from providing any commentary on potential changes to its indexes.

Factors Considered by the S&P Dow Jones Indices

When making decisions about the composition of the Dow Industrials, the S&P Dow Jones Indices takes into account several factors. One critical consideration is the stock price, as components of the index are weighted based on stock price rather than market value. This distinguishes it from the S&P 500 index and most other major equity indexes.

Conclusion

Walgreens' position in the Dow Industrials hangs in the balance, given its significant decline in stock value. If changes occur this year, the removal of Walgreens seems likely. However, the potential replacements for this iconic pharmaceutical company are equally noteworthy, with companies like Google parent Alphabet and Amazon.com being strong contenders. Only time will tell how these changes will affect the composition of the index.

The Weighting System of the Dow Jones Industrial Average

The Dow Jones Industrial Average (Dow) is a stock market index that has been a key indicator of the American stock market since its inception in 1896. Despite the technological advancements of the modern era, the Dow still utilizes a price weighting system, which simplifies the calculation of the index's value.

How the Index is Calculated

To determine the value of the Dow, the prices of the 30 components are added together and multiplied by the inverse of the divisor. Currently, the index is valued at approximately 37,500. However, due to its price-based methodology, the Dow's composition does not always accurately reflect the overall market performance.

The Impact of Stock Prices on Weighting

In the Dow, each component's weighting is heavily influenced by its stock price. For instance, UnitedHealth Group holds the highest weighting in the index with a stock price of around $546. In contrast, Walgreens has a significantly lower weighting due to its lower stock price. This discrepancy demonstrates that a stock's price can greatly affect its prominence in the Dow.

Changes in the Dow

The last adjustment to the Dow's composition took place in August 2020. Salesforce.com, Honeywell, and Amgen were added, while Exxon Mobil, Raytheon Technologies (now RTX), and Pfizer were removed. Prior to that change, Walgreens was added in June 2018 at the expense of General Electric. Other notable modifications occurred in March 2015 when Apple replaced AT&T.

Current Standings and Impactful Companies

As of now, Alphabet and Amazon are prominent players in the stock market, ranking third and fourth respectively behind Apple and Microsoft. With stock prices around $140, both Alphabet and Amazon have the potential to significantly impact the Dow. On the other hand, companies like Intel and Verizon have minimal effects on the index due to their lower stock prices ($47 and $39 respectively). Interestingly, despite its smaller market value, Travelers holds a notable impact with a share price of $195.

In conclusion, the Dow Jones Industrial Average maintains its historical reliance on a price weighting system to gauge the stock market. Even in the modern age, this methodology continues to be a key factor in determining the index's value and components.