Created in 1896 by Wall Street Journal cofounder Charles Dow, the Dow Jones Industrial Average is America’s oldest stock market index, but that’s not the only thing that makes it stand out among its peers. It’s also smaller than most other indexes, comprising just 30 blue-chip companies, and the way it’s constructed (and deconstructed and reconstructed) is also unique.
The composition of most other bellwether indexes — i.e., the stocks they include — is standardized, with fairly simple criteria determining which companies end up in the index and which don’t. The S&P 500, for instance, includes the 500 largest American companies by market capitalization, assuming they meet the index’s other inclusion criteria (profitability requirements, float requirements, etc.). It is managed by an oversight committee that meets quarterly to rebalance it and ensure its composition aligns with its inclusion criteria.
The Dow also has inclusion criteria, but they are significantly less specific, and when it comes to which companies make the cut, the decision ultimately rests with just five people, known collectively as the “averages committee.” And because of the Dow’s small size and relatively loose inclusion criteria, the averages committee has far more decision-making power than the committees that oversee more standardized indexes like the S&P 500.
Here’s everything you need to know about the averages committee and how they decide which stocks to add to and drop from the Dow.
What is the Dow’s averages committee?
The Dow Jones Industrial Average is designed to serve as a benchmark for the U.S. stock market and economy at large by tracking the collective prices of 30 mature, blue-chip companies that together represent the best of the industries that make up the American economy.
The Dow’s averages committee is responsible for ensuring that the index’s composition remains true to this purpose by dropping companies that no longer fit these criteria and replacing them with companies that do.
Related: What happens when a stock splits in the Dow Jones Industrial Average?
The averages committee includes only five people — three representatives from S&P Dow Jones Indices (the LLC behind both the Dow and the S&P 500) and two representatives from the Wall Street Journal (the financial news outlet founded by Charles Dow).
These five individuals work together to monitor the health and viability of the companies in the Dow and make adjustments when necessary to maintain the index’s continuity and viability as a benchmark.
What criteria must a stock meet to be included in the Dow?
When choosing a stock to include in the Dow, the averages committee has quite a bit of leeway, though certain criteria are strongly considered, which narrows the pool of candidates to a more manageable size.
To be considered for the Dow, a company must …
- Be headquartered and incorporated in the U.S.
- Be a non-transportation, non-utility stock included in the S&P 500
- Have a good reputation and a history of sustained growth
- Have a large number of investors
Related: Dow Jones’ revolving door: What happens to a stock after it’s dropped from the DJIA?
What other factors does the averages committee consider when adding or dropping a stock from the Dow?
In addition to the above criteria, the averages committee also considers the following questions when considering adding a stock to the DJIA:
- Is this company a leader in its industry?
- Does it have a history of increasing dividend payments to shareholders?
- Will its inclusion help the index accurately represent the sector balance of the U.S. economy?
- Is its stock price appropriate for its weighting in the index? (The DJIA is price-weighted, which is unusual, so stock prices — which can be arbitrary — must be considered to avoid weighting problems.)
Related: The Dow’s best dividend stocks: A shortlist for income investors
Why is the Dow’s averages committee different from other stock index oversight committees?
Because the Dow’s inclusion criteria are far looser and less standardized than those of, say, the S&P 500, the averages committee holds quite a bit of decision-making power, especially since the DJIA is such a frequently cited benchmark in financial and economic news.
In a way, the Dow has become something of an “all-star team” of American stocks, and its small size makes a company’s inclusion a sought-after accolade.
While most other indexes are “constructed” according to a relatively strict set of criteria, the Dow is “curated,” with factors such as reputation, investor popularity, and industry leadership influencing the committee’s decisions.
With so many healthy, mature companies to choose from, the averages committee’s choices aren’t always easy, and when they drop a stock from the Dow’s ranks and replace it with a new one, both companies tend to receive heightened interest and scrutiny from investors — retail and institutional alike.
When a stock is dropped from the Dow, it can signal to investors that the company’s growth has slowed or stalled, or that it is losing cultural or economic relevance. When a company is added to the Dow, it can signal that it has transformed from a rising star to an established sector leader and a mainstay in the American economy.
