- Stock splits from Amazon and Alphabet could mean a big change for the Dow Jones Industrial Average.
- Both Amazon and Alphabet are moving forward with a 20-for-1 stock split, which will reduce their stock price from the thousands to about $140.
- Companies with sky-high stock prices are not compatible with the Dow Jones due to its price-weighted methodology.
Upcoming 20-for-1 stock splits from tech giants Alphabet and Amazon could lead to a big shakeup in the 126-year old Dow Jones Industrial Average later this year.
That's because the 30-member index popular with investors is price weighted, which means sky-high stock prices are usually a limiting factor to be included in the index.
Whereas the S&P 500 ranks its holdings based on the market value of its constituents, the Dow Jones ranks its holdings based on the absolute level of its constituents' stock price.
That means UnitedHealth Group has a higher weighting than Apple in the Dow Jones because its current stock price of about $485 is more than double Apple's current stock price of about $160. That's despite the fact that Apple is six times the size of UnitedHealth Group based on the traditional market capitalization measure.
There is little criteria for a company to be included in the Dow Jones, other than that the stock has to already be included in the S&P 500, and is not a utility or transportation company.
According to guidelines from S&P Dow Jones Indices, a stock "typically is added to the index only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors." It's safe to say that Alphabet and Amazon both meet those criteria.
And a post-stock split inclusion in the index wouldn't be the first time a mega-cap tech company joined the Dow Jones index. Apple was added to the Dow Jones in 2015, about nine months after it enacted a 7-for-1 stock split that brought its stock price down to about $100 from about $700.
Once the stock splits are enacted, Alphabet and Amazon's stock price will fall from a current price of $2,668 and $2,885 to about $133 and $144, respectively. As to who the mega-tech giants will replace in the index, potential candidates include the two smallest constituents of the index, Walgreens and Intel.
Amazon replacing Walgreens would make sense given that both companies are categorized as consumer stocks, while Alphabet replacing Intel could happen given both have a strong tech focus.
Gene Munster of Loup Ventures believes it's inevitable that all of the mega-cap tech companies will be added to the Dow Jones index.
"Eventually, all these big tech companies are going to find their way into the Dow because eventually they will all become essentially consumer staple companies," Munster told CNBC on Thursday.