The Dow Jones Industrial Average (DJIA), is a stock market index that indicates the value of 30 large, publicly owned companies based in the United States, and how they have traded in the stock market during various periods of time. These 30 companies are also included in the S&P 500 Index. The value of the Dow is not a weighted arithmetic mean and does not represent its component companies’ market capitalization, but rather the sum of the price of one share of stock for each component company. The sum is corrected by a factor which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index.
It is the second-oldest U.S. market index after the Dow Jones Transportation Average, created by Wall Street Journal editor and Dow Jones & Company co-founder Charles Dow. Currently owned by S&P Dow Jones Indices, which is majority owned by S&P Global, it is the best known of the Dow Averages, of which the first (non-industrial) was originally published on February 16, 1885. The averages are named after Dow and one of his business associates, statistician Edward Jones. The industrial average was first calculated on May 26, 1896.
The Industrial portion of the name is largely historical, as many of the modern 30 components have little or nothing to do with traditional heavy industry. Since the divisor is currently less than one, the value of the index is larger than the sum of the component prices. Although the Dow is compiled to gauge the performance of the industrial sector within the American economy, the index’s performance continues to be influenced by not only corporate and economic reports, but also by domestic and foreign political events such as war and terrorism, as well as by natural disasters that could potentially lead to economic harm.
The DJIA as a Dollar Value
To figure out how a change in any particular stock affects the index, divide the stock’s price change by the current divisor. For example, if Walmart (WMT) is up $5, divide five by current divisor (0.14523396877348), which equals 34.42. Thus, if the DJIA was up 100 points on the day, Walmart was responsible for 34.42 points of the move.
The Dow and the Economy
Despite its limitations, the Dow still serves three important functions in today’s marketplace:
1. The long history of the Dow serves as a reminder of and comparison for today’s market as compared to early markets. Trend analysis is always important when trying to forecast the future and the longevity of the Dow serves this purpose better than all other indices.
2. While the Dow tracks only 30 large American companies, these companies are inclusive of all industries except utilities and transportation, creating a broad overview of the economy. In general, the stock market is a leading indicator and the trend of the Dow could be construed as representing the trend of the economy over the next year. It may not have predictive power in ascertaining the level of economic activity but should be able to have directional predictability.
3. The Dow garners an unmistakable and perhaps unwarranted amount of attention from the media. Reporting on how the Dow fared on a particular day is pervasive and it is used as a proxy for the state of the economy. So even though the Dow is not fully representative of a global, technology-driven market, the psychological connection of it with the state of the economy is profound.
The Bottom Line
After 137 years as a marker of major market developments, the DJIA is still one of the most recognized and cited of all market indexes. While it may not represent the new market opportunities and early-stage fast-growing companies, and may not be indicative of the overall economic strength of the U.S. economy given most of the companies in the Index procure a high percentage of revenue outside the U.S., it does provide some valuable purposes. So, despite all its shortcomings, the Dow is still one of the most-watched indicators for stock market performance and the shape of the U.S. economy.