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. T
raditionally, 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: