The Dow Jones Industrial Average (also called The Dow, Dow 30 and the DJIA) is what most Americans think of as the “stock market.”  The widely followed benchmark of 30 American stocks, however, no longer offers an accurate picture the U.S. economy and needs to be changed.

Clarence Dow, co-founder of the Wall Street Journal, created the average in 1896. Most histories of the DJIA say that its components have been changed 48 times. Traditionally, the senior editorial staff of The Journal decided which companies made up the benchmark.  Dow Jones, The Journal’s parent, no longer owns any of the Dow indices. The CME Group, which runs the world’s largest futures exchange, bought 90% of the operation in early 2010.

The term “industrial” is now a misnomer. The DJIA includes financial firms such as Bank of America (NYSE: BAC) and technology companies including Microsoft (NASDAQ: MSFT). Some of the Dow components were added decades ago. General Electric joined the index in 1907. The most recent additions, Travelers (NYSE: TRV ) and Cisco (NASDAQ: CSCO), were added in mid-2009.

There are no firm rules about how companies are chosen for the DJIA. Members of the index are supposed to be very large American corporations that represent a broad cross-section of the economy. The index is weighted by an arcane formula based on a “divisor.”  Here is how CME explains its methodolgy:

“A price-weighted index is calculated using only the component’s stock prices, summed up and divided by the DJIA Divisor. The number of outstanding shares of each stock is not used. Therefore, the weight of a stock in the DJIA is simply determined by the stock’s price. The stock with the highest price will have the highest weighting in the DJIA.”

The biggest problem with the DJIA is that it no longer reflects the economy. The index includes old industrial companies such as Alcoa (NSYE: AA). Some components have extremely small market capitalizations. For instance Alcoa’s market cap is only $14.5 billion. That means it is not even in the top 200 publicly traded companies in the US based on market value.

24/7 Wall St. has analyzed all 30  DJIA members to determine which best represent the U.S.  economy and have picked five companies that should be removed from the DJIA.   We then looked at some of America’s largest and most important companies and determined which ought to be added to the index.

These are the five companies that should be dropped from the Dow and the five companies that should take their place:

Companies That Should Be Dropped:

1. Alcoa Inc. (NYSE: AA). The metals refiner has sales of under $20 billion. The company is part of America’s “old” economy. Most of the firms that control the metals businesses worldwide are in China or are large multinationals like BHP Billiton (NYSE: BHP) or Rio Tinto (NYSE: RTP). Alcoa’s stock price was over $40 in 1999. It is now $14.
2. United Technologies Corp. (NYSE UTX) is no longer one of the dominant companies in the US. It is the third largest American-based conglomerate behind GE (NYSE: GE), which is in the DJIA, and Berkshire Hathaway (NYSE: BRK.B), which is not. United Technologies had revenue of $53 billion last year. Among its largest business are the manufacturing of elevators,  air-conditioning and heating units and fire and securities systems. United Technologies in not involved in many businesses which are strategic to the growth of the American economy.
3. The Travelers Companies, Inc. (NYSE: TRV). The insurance company was added in 2009, but it is hardly a reasonable proxy for the non-banking financial services sector. Travelers’ market cap is only $25 billion. Its products are almost exclusively in the insurance industry.   The DJIA already has Bank of America (NYSE: BAC), JP Morgan Chase (NYSE: JPM) and, American Express (NYSE: AXP) as components.
4. Verizon Communications Inc. (NYSE: VZ). The DJIA is over-weighted in the telecommunications sector because of the inclusion of AT&T (NYSE: T) which is the No. 11 American company by market cap. AT&T and Verizon are in nearly identical businesses. Each has a large but shrinking landline phone business, a nationwide cellular business, and emerging divisions which provide TV and broadband to the home over fiber optics systems.
5. E.I. du Pont de Nemours and Co. (NYSE: DD). Another company which is much more representative of the old US economy, it is a legacy member of the DJIA, added in 1935. The company’s sales are only $29 billion and the firm’s revenue is not growing. Much of DuPont’s sales come from businesses such as packaging, paint, plastics, printing material, and chemicals.

Companies That Should Be Added To The DJIA:

1. Apple Inc. (NASDAQ: AAPL). It is hard to imagine how Apple could be excluded from any major index of companies which trade on US exchanges. Apple is a proxy for the PC, consumer electronics, cellular and entertainment industries. It is one of the fastest-growing large American companies. It considered to be one of the most innovative firms in the world. Apple is the No.2 American corporation in terms of market cap behind Exxon Mobil (NYSE: XOM).  Apple’s share price has risen from $9 in 2000 to nearly $320 today.
2. Berkshire Hathaway Inc.(NYSE: BRK-A). This conglomerate has large subsidiaries in the insurance, railroad, home building, air travel, and energy industries. The firm, run by business legend Warren Buffett, also has one of the most diversified and largest stock portfolios of any corporation in the world. The company has positions in companies which represent every important industry in the US. Berkshire Hathaway is also the 6^th biggest publicly traded company by market cap.
3. Google Inc. (NASDAQ: GOOG). The world’s largest search engine company is a proxy for every major Internet company in America. Its business is also representative of the online operations of many  large companies. Google is part of the US economy which includes huge online firms like Amazon.com (NASDAQ: AMZN) and Ebay (NASDAQ: EBAY) as well as the e-commerce divisions of traditional firms like Wal-Mart. Google is the fifth largest company in America based on its market cap.
4. Goldman Sachs Group, Inc. (NASDAQ: GS). The most successful new-economy financial firms are those with large investment bank, M&A, debt and equity financing, trading, derivatives, and asset management operations. Goldman is the most highly regarded investment banking operation in the world, despite the damage done by the credit crisis. Goldman has a large presence in the critical global clearing, asset management, and derivatives sectors. It has the largest global market share most years in the IPO, and debt and equity and underwriting businesses.
5. Ford Motor Co. (NYSE: F). Once in a while, a very old business become a critical part of the new economy. The auto industry in America is in the midst of a renaissance. Ford is considered the most successful vehicle manufacturer in the US. It avoided the bankruptcies that befell GM and Chrysler. It has nearly caught GM in total domestic sales and its monthly figures have grown at a rate that eclipses many of the imports that have been so successful in the past. Ford has large operations in every major car and light vehicle market in the world. It is a proxy for the entire industry in both the US and overseas.

Douglas A. McIntyre

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