Dow Jones Industrial Average Explained

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Dow Jones Industrial Average (DJIA)

What Is the Dow Jones Industrial Average (DJIA)?

The Dow Jones Industrial Average (DJIA) is an index that tracks 30 large, publicly-owned blue chip companies trading on the New York Stock Exchange (NYSE) and the NASDAQ. The Dow Jones is named after Charles Dow, who created the index back in 1896, along with his business partner Edward Jones.

Key Takeaways

  • The Dow Jones Industrial Average (DJIA) is a widely-watched benchmark index in the U.S. for blue-chip stocks.
  • The DJIA is a price-weighted index that tracks 30 large, publicly-owned companies trading on the New York Stock Exchange and the NASDAQ.
  • The index was created by Charles Dow in 1896 to serve as a proxy for the broader U.S. economy.

The Dow Jones Industrial Average

Understanding the Dow Jones Industrial Average

Often referred to simply as “the Dow,” the DJIA is one of the oldest, single most-watched indices in the world. To investors, the Dow Jones is defined as a collection of blue-chip companies with consistently stable earnings that include Walt Disney Company, Exxon Mobil Corporation, and Microsoft Corporation. When the TV networks say “the market is up today,” they are generally referring to the Dow.

The Dow Jones Industrial Average is the second oldest U.S. market index after the Dow Jones Transportation Average, which contains 20 transport stocks such as railroad and trucking companies. The Dow Jones Industrial Average was designed to serve as a proxy for the broader U.S. economy.

When the Dow Jones index launched, it included just 12 companies that were almost purely industrial in nature. The early components of the Dow operated in industries that included railroads, cotton, gas, sugar, tobacco, and oil. The performance of industrial companies is typically tied to the growth rate in the economy. As a result, the relationship between the Dow’s performance and that of the economy was cemented. Even today, to many investors, a strong Dow means a strong economy while a weak-performing Dow means a slowing economy.

As the economy changes over time, so does the composition of the index. The Dow typically makes changes when a company becomes less representative of the economy or when a broader economic shift occurs, and a change needs to be made to reflect it.

For example, a company that loses market capitalization due to financial distress might be removed from the Dow. Market capitalization is a method of measuring the value of a company by multiplying the number of shares outstanding to its stock price.

How the Index Is Calculated

Stocks with higher share prices are given greater weight in the index. So, a higher percentage move in a higher-priced component will have a greater impact on the final calculated value. At the Dow’s inception, Charles Dow calculated the average by adding the prices of the twelve Dow component stocks and dividing by twelve with the end result being a simple average. Over time, there have been additions and subtractions to the index, such as mergers and stock splits that had to be accounted for whereby an arithmetic mean would not suffice any longer.

This led to the advent of the Dow Divisor, a predetermined constant (though it can be changed if the need should arise) that is used to determine the effect of a one-point move in any of the thirty stocks that comprise the Dow. There have been instances (components added or removed, stock splits, etc.) when the divisor needed to be changed so that the value of DJIA stayed consistent. The current divisor can be found in the Wall Street Journal and is 0.14748071991788.

The key point about the DJIA is that it is not a weighted arithmetic average, nor does it represent its component companies’ market capitalization as does the S&P 500. Rather, it reflects the sum of the price of one share of stock for all the components, divided by the divisor. Thus, a one-point move in any of the component stocks will move the index by an identical number of points.

DJIA Price = SUM (Component stock prices) / Dow Divisor

Changes to the Index Over Time

The index grew to 30 components in 1928 and has changed components a total of 51 times. The first change came just three months after the index was launched. In its first few years until roughly the Great Depression, there were many changes to its components. In 1932, eight stocks within the Dow were replaced. However, during this change, the Coca-Cola Company and Procter & Gamble Co. were added to the index, two stocks that are still part of the Dow in 2020.

The most recent large scale change to the Dow took place in 1997 when four of the index’s components were replaced. Two years later, in 1999, four more components of the Dow were changed. The most recent change took place on June 26, 2020, when Walgreens Boots Alliance, Inc. replaced General Electric Company.

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Components of the Dow

The table below alphabetically lists the companies included in the DJIA as of March 18, 2020:

Finance 101: Dow Jones explained

Amid weeks of stock-market turmoil, many worried investors have been tracking the daily trajectory of the Dow Jones industrial average like.

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NEW YORK — Amid weeks of stock-market turmoil, many worried investors have been tracking the daily trajectory of the Dow Jones industrial average like never before.

But few understand how the index of 30 of the biggest U.S. companies is calculated or what the closely watched measure of stock market performance really means.

Here are some questions and answers about the world’s most famous stock index.

Q. What is the Dow Jones industrial average?

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A. The Dow, the oldest continuing U.S. market index, is a way to measure the combined stock values of 30 big U.S. companies.

It started out with 12 components, including now-defunct companies like U.S. Leather and Tennessee Coal, Iron and Railroad. The only original component still around is General Electric.

The index has expanded to reflect the U.S. economy’s move away from big industrial companies. Staples of the modern Dow include big financial companies like Citigroup, technology bellwether IBM and drug manufacturer Pfizer.

Q. How is it calculated?

A. Charles Dow, who launched the index in 1896, originally took the price of one share of each company’s stock, added the numbers up and divided by the number of companies. The average when the index launched was 40.94 — a quaint little number compared with Monday’s close of 9,387.61, or the Dow’s record high of 14,165.43 on Oct. 9, 2007.

Today, Dow Jones & Co. has a mathematical formula to adjust for things like stock splits — when a company doubles the number of stocks its shareholders have, splitting the price of each in half — or new companies being added or removed.

The idea is to keep the index consistent over time and to make sure today’s value can be compared in a meaningful way to what it was a year ago or 10 years ago.

This can be done various ways mathematically, but at Dow Jones it is handled by changing the “divisor” — a number divided into the total of the stock prices. That divisor currently stands at 0.122820204.

Q. How does the index account for the fact some components are bigger than others?

A. The index is what’s called a “price-weighted average,” meaning expensive stocks have more influence over the number than lower-priced ones. This is because the index is based purely on the dollar value of stocks; if a high-priced share goes up 20 percent, that’s a greater dollar increase than a cheaper share’s 20 percent jump.

For example, a sharp drop in the price of General Motors last week didn’t have a huge effect on the Dow because the automaker’s stock was already so low. The stock fell $2.15, or 31 percent, on Thursday but only lowered the Dow by 17.1 points. GM’s drag wasn’t all that noticeable on a day when the Dow plunged 679 points.

Q. Is the Dow considered a good measure of how the nation’s companies are generally faring in the stock market?

A. Yes and no. Some on Wall Street downplay the importance of the average because it isn’t as broad a measure as counterparts like the Standard & Poor’s 500 index, which reflects the performance of 500 companies’ stocks.

Still, the Dow is the granddaddy of U.S. market indexes, and it offers a relatively easy-to-understand snapshot of how the market is faring. Analysts generally believe it is a useful tool when combined with other market indicators, including the S&P 500 and the Nasdaq composite, an index of shares on the tech-heavy Nasdaq Stock Market.

Q. What are the 30 members of the index?

A. The companies are: 3M, Alcoa, American Express, AT&T, Bank of America, Boeing, Caterpillar, Chevron, Citigroup, Coca-Cola, DuPont, ExxonMobil, General Electric, General Motors, Hewlett-Packard, Home Depot, Intel, IBM, Johnson & Johnson, JPMorgan Chase, Kraft Foods, McDonald’s, Merck, Microsoft, Pfizer, Procter & Gamble, United Technologies, Verizon, Wal-Mart and Walt Disney.

How Does the Dow Jones Industrial Average Work?

The most famous stock market barometer is the Dow Jones Industrial Average (DJIA). When someone asks how the market is doing, most investors quote the DJIA (simply referred to as “the Dow”). The Dow is price weighted and tracks a basket of 30 of the largest and most influential public companies in the stock market.

The following list shows the current roster of 30 stocks tracked on the DJIA (in alphabetical order by company with their stock symbols in parentheses).

Alcoa (AA) Honeywell International Inc. (HON)
Altria (MO) Intel (INTC)
American Express Co. (AXP) International Business Machines (IBM)
American International Group (AIG) Johnson & Johnson (JNJ)
Boeing (BA) J.P. Morgan Chase (JPM)
Caterpillar (CAT) McDonald’s (MCD)
Citigroup (C) Merck (MRK)
Coca-Cola (KO) Microsoft (MSFT)
Disney (DIS) Minnesota Mining and Manufacturing (3M) (MMM)
DuPont (DD) Pfizer (PFE)
Exxon Mobil (XOM) Procter & Gamble (PG)
General Electric (GE) SBC Communications (SBC)
General Motors (GM) United Technologies (UTX)
Hewlett-Packard (HPQ) Verizon (VZ)
Home Depot (HD) Wal-Mart Stores (WMT)

The Dow has survived as a popular gauge of stock market activity for over a century. Although it’s an important indicator of the market’s progress, the Dow does have one major drawback: It tracks only 30 companies.

Regardless of their status in the market, the companies in the Dow represent a limited sampling, so they don’t communicate the true pulse of the market. For example, when the Dow surpassed the record 10,000 and 11,000 milestones during 1999 and 2000, the majority of (nonindex) companies showed lackluster or declining stock price movement.

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