The Dow Jones Industrial Average is one of the earliest examples of a stock index, a collection of 30 blue-chip company stocks that are calculated into one number that’s supposed to represent the U.S. stock market as a whole or a subset of it.
Now there are hundreds of indices, which represent everything from smaller companies (The Russell 2000), to specific industries, like the KBW Bank Index, to the S&P 500 — the oft-cited index that represents a broad cross-section of America’s largest companies. But the Dow is still watched, domestically and worldwide, as a leading market indicator.
What Is the Dow Jones Industrial Average?
The Dow Jones Industrial Average is based on the performance of 30 companies that represent the industry leaders in the world economy: Apple, Microsoft, JP Morgan Chase, Nike, Coca-Cola, Walmart, Disney, along with companies like Dow or Caterpillar that you may not be as familiar with, but are massive and play an important role in business in the United States and around the world.
The Dow is considered an index of blue-chip companies, which signals not only some of the largest companies, but also the most solid and well established.
Nonetheless, the companies on the Dow Jones Industrial Average change regularly, reflecting changes in the U.S. economy.
It’s important for investors to follow the Dow, as it’s one of the leading stock market indicators. And while it’s certainly not the only one, understanding the Dow’s movements in addition to other indicators can help inform your investing strategy.
What Makes the Dow Jones Industrial Average Different?
The Dow Jones Industrial Average is just one of many collections of stocks whose value is represented in a single number. The Dow Jones Industrial Average isn’t just distinct because of its age, but because of how it’s calculated.
The other two major stock indices that are frequently cited as bellwethers of the overall market, the S&P 500 and the Nasdaq Composite, are both “market capitalization weighted,” whereas the Dow Jones Industrial Average is “price-weighted.”
That means that the Dow Jones Industrial Average’s “points” are calculated from the per-share price of every stock in the index, as opposed to the company’s overall value. As such, the DJIA doesn’t reflect the overall stock market return, but rather it can be used as a gauge of market trends and/or investor sentiment.
In a market-weighted index, the influence any given stock has over the index’s overall value is determined by a company’s market capitalization or market cap. A company’s market cap is determined by multiplying the number of shares by the value of the stock.
In this type of index, the influence of a company is determined by how valuable the company is, not solely by the price of a stock.
Example of How Stock Price Can Skew an Index
Apple only joined the Dow Jones Industrial Average after it did a stock split, lowering its per share price from around $650 to under $100, but increasing the number of shares by seven. Had it split its stock before joining the Dow, it would have entered the index with a price of nearly $900, as opposed to around $126, giving the company an outsize role on the index.
Because the Dow Jones Industrial Average is price weighted, adding companies with hefty per-share price tags could cause problems. That’s the main reason that companies like Alphabet, the parent company of Google, and Amazon, aren’t included in the index. On the other hand, Microsoft, which is worth over $1 trillion, is priced at below $200 a share and is a member of the Dow Jones Industrial Average.
The Dow Divisor
Today’s economy is far different from the late 19th century or the late 1920s — the number of industries in which the U.S. has large, established companies has grown, and the size of those companies is bigger.
In order to account for some of these changes over time, the Dow Divisor is used to determine the value of the Dow Jones Industrial Average. Using the Dow Divisor can help in historical comparisons and account for differences that may arise due to a stock split or other factors.
How the Dow Jones Industrial Average Changed Over Time
The Dow Jones Industrial Average is intimately tied up with the history of the markets and American financial journalism. The Dow Jones Industrial Average is just eight years younger than the Wall Street Journal, which was founded in 1889, while the Dow Jones Industrial Average was founded as a 12-company index in 1896.
The Dow Jones Industrial Average was originally developed by Charles Dow and Edward Jones.
But it wasn’t the first ever stock index; that title belongs to the Dow Jones Transportation Average, a collection of railroad stocks that Dow came up with in 1884.
The 12 companies initially included in 1896 were companies that reflected the shape of the American economy — largely manufacturing and agricultural companies and the transportation networks that helped move goods. The companies included in that first year were:
• American Cotton Oil
• American Sugar
• American Tobacco
• Chicago Gas
• Distilling & Cattle Feeding
• General Electric
• Laclede Gas
• National Lead
• North American
• Tennessee Coal & Iron
• U.S. Leather
• U.S. Rubber
The Dow Jones Industrial Average in the 20th Century
The index was expanded to its current number of 30 in 1928, and by 1932 the Index started to resemble the American economy as we might recognize it today, with a mixture of manufacturing (General Motors, Chrysler), retail (Sears, Woolworth), consumer (Coca-Cola, Procter & Gamble) technology (IBM) and energy (multiple descendants of John Rockefeller’s Standard Oil).
The first companies associated with the personal computer revolution came much later (IBM being an exception), with Hewlett-Packard getting added in 1997, Intel and Microsoft added in 1999, and Apple only joining the Dow in 2015, when it replaced AT&T.
Walmart was added to the index in 1997. America’s entertainment industry, one of its leading export industries, was only represented in the index in 1991, when Disney was added.
Right now the Dow Jones Industrial Average “covers all industries except transportation and utilities,” according to S&P Dow Jones Indices.
While the Dow Jones Industrial Average is managed by S&P Dow Jones Indices, it still retains a connection with the Wall Street Journal and its publishing company, Dow Jones. The editor of the paper is part of the committee that determines membership in the Dow Jones Industrial Average.
The Takeaway
Investors can look to the Dow Jones Industrial Index as an overall indicator of how the largest companies in the U.S. are performing. Historically, the Dow Jones Industrial Average has shown similar returns to the S&P 500, which tracks 500 large-cap U.S. companies.
Indexes, like the Dow Jones Industrial Index, can provide helpful insight for investors. They can be used to help investors compare current and past stock prices, to determine the market performance. Understanding this information can be helpful to investors as they review their own portfolio and adjust their investing strategy.
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