Investing Advice

Dow Jones Industrial Average

The number one watched stock market index is the Dow Jones Industrial Average, There are also Dow Jones Utility and Transportation Averages, but when we refer to the DOW, it's the industrial average that we are all talking about.

We hear "the Dow is up, the Dow is down". Everyone seems to know that it's a number that represents the stock market. To some of us, it is the market.

The Dow is made up of 30 American companies representing major industries. All but 2 of these are traded on the NYSE, along with Intel and Microsoft which are traded on the NASDAQ.

Charles H. Dow, with the urging of Collis Huntington (builder of the Union Pacific Railroad) co-founded Dow Jones and Company in 1882. With his partner Edward Jones, he began his famous market tracking index on July 3, 1884. This original index represented the average stock price of just 11 companies, most of them railroads, and was first published in Dow's Customerís Afternoon News Letter and then in the Wall Street Journal which he began in 1889. On May 26, 1896 the Dow average was expanded to 12 companies, then 20 in 1916, and finally 30 companies in 1928.

The editors of the Wall Street Journal, published by Dow Jones and Company, changes the list from time to time to reflect the leading companies in America's most important industries.

Here are some of the early companies on the Dow list:

American Cotton Oil
American Sugar
Distilling and Cattle Feeding
General Electric
Laclede Gas
Natural Lead
Tennessee Coal and Iron U.S. Leather

Other companies included over the years have been Victor Talking Machines, Remington Typewriter, and Studebaker Automobiles.

Today, we have
Alcoa, American Express, AT&T, Boeing, Caterpillar, Citigroup, Coca Cola, Dupont, Disney, Eastman Kodak, Exxon Mobil, General Electric, General Motors, Home Depot, Honeywell, Hewlett-Packard, IBM, International Paper, Merck, Johnson & Johnson, JP Morgan, McDonald's, 3M, Microsoft, Philip Morris, Proctor & Gamble, SBC Communications, United Technologies, and Wal-Mart.
 

In just the past few years, Allied Signal, Chevron, Goodyear, Sears, Travelers Group, Avistar, Primerica, USX Corp, and Union Carbide were replaced with Citigroup, Home Depot, Honeywell, Intel, Microsoft, Disney, Caterpillar, JP Morgan, and SBC Communications. In 1972, there were also American Can, Anaconda Copper, Bethlehem Steel, Chrysler, F.W. Woolworth, Intíl Nickel, Owens-Illinois Glass, Swift, and Westinghouse.

How is the Dow calculated? Originally you just added up the prices of the 12 companies and divided by 12, very simple. In 1928, a divisor of 16.67 was used to adjust for mergers, takeovers, bankruptcies, stock splits, and company substitutions. Today, we add up the 30 stock prices and divide by .14452421. This means that for every $1 move in a Dow's stock price, the average changes about $6.92.

If this seems like a good way to measure the performance of the stock market to the news services, it is because no one seems to want to declare how ridiculous the Dow Jones Industrial Average really is. Consider this:

  • The Dow measures the performance of only 30 companies out of thousands.

  • These companies are selected by the editors of a newspaper

  • If one of these companies isn't doing well, they substitute it with a hot new company, as when they kicked off Woolworth's to make way for McDonald's

  • All stocks are considered equally. If a $100 stock goes up $2 or just 2%, it moves the index exactly the same amount as a $20 stock going up the same $2 or 10%.

  • The Dow does not include the effect of dividends, which over time can make a substantial difference

  • The index is not market cap weighted as the S&P 500 is. This is important as you will see from this example:
     
    The Dow at its high on 1-14-00 was 11,722.98, and the total value of all the stock in the 30 Dow companies was $4.38 trillion. 14 months later, the index had dropped 16.8%, but the market value of these companies had dropped 25.6%. In plain English, the Dow went down 17%, but investors lost a whopping 26%. That's an extra $400 billion.

For all its shortcomings, the Dow is an important measure of the market. It has withstood the test of time in fairly accurately reflecting the health of the market. It's reported everywhere, in newspapers, TV, and radio. It influences how investors feel about the market.

When someone talks about the market's ups and downs, they're talking about the Dow. You need to pay attention to it because everyone else is.

The Dow's worst one-day drop wasn't Black Thursday on October 28, 1929, or Black Friday on the 29th (their two-day combined loss was 24%). It was Black Monday on October 19, 1987 when the average plunged 508 points and 23%.

Other Stock Market Basics Topics:

  1. What is a stock market index?
  2. Dow Jones Industrial Average
  3. S&P 500 (Standard and Poorís, a McGraw-Hill Company)
  4. Other S and P Indexes
  5. The NASDAQ
  6. Wilshire Indexes
  7. Barra Indexes
  8. Russell (Frank) Indexes, Covering the Nasdaq stocks
  9. EAFE Index

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