An index is not biased if its performance can be replicated or
matched by an investor. To replicate an index, the date of additions and
deletions to the index must be announced in advance so that new stocks
can be bought and deleted stocks can be sold. This is particularly impor-
tant for issues that enter into bankruptcy: the postbankrupt price (which
might be zero) must be factored into the index. All the major stock in-
dexes, such as Standard & Poor’s, Dow Jones, and the Nasdaq, can be
replicated by investors.^7 Consequently, there is no statistical reason to
believe that capitalization-based indexes give a biased representation of
the return on the market.APPENDIX: WHAT HAPPENED TO THE
ORIGINAL 12 DOW INDUSTRIALS?
Two stocks (General Electric and Laclede) retained their original name
(and industry); five (American Cotton, American Tobacco, Chicago Gas,
National Lead, and North American) became large public companies in
their original industries; one (Tennessee Coal and Iron) was merged into
the giant U.S. Steel; and two (American Sugar and U.S. Rubber) went
private—both in the 1980s. Surprisingly, only one (Distilling and Cattle
Feeding) changed its product line (from alcoholic beverages to petro-
chemicals, although it still manufactures ethanol), and only one (U.S.
Leather) liquidated. Here is a rundown of the original 12 stocks (market
capitalizations as of March 2007):
American Cotton Oilbecame Best Food in 1923, Corn Products Re-
fining in 1958, and finally, CPC International in 1969—a major
food company with operations in 58 countries. In 1997, CPC
spun off its corn-refining business as Corn Products Interna-
tional and changed its name to Bestfoods. Bestfoods was ac-
quired by Unilever in October 2000 for $20.3 billion. Unilever
(UN), which is headquartered in the Netherlands, has a current
market value of $43.2 billion.
American Sugarbecame Amstar in 1970 and went private in 1984. In
September 1991 the company changed its name to Domino
Foods, Inc., to reflect its world-famous Domino line of sugar
products.CHAPTER 3 Stock Indexes 47
(^7) The original Value Line Index of 1,700 stocks, which was based on a geometric average of the
changes in the individual stocks, was biased downward. This eventually led Value Line to abandon
the geometric average in favor of the arithmetic one, which could be replicated.