Dow Jones Industrial Average (DJIA)

"The Dow"

What is the Dow Jones Industrial Average (DJIA)?

The Dow Jones Industrial Average (DJIA), also commonly referred to as “the Dow Jones,” or simply “the Dow”, is one of the most popular stock-market indices, and it measures the daily stock market movements of 30 U.S. publicly-traded companies listed on NASDAQ and New York Stock Exchange (NYSE). The 30 public owned companies are chosen by the editors of Wall Street Journal and are considered leaders in the United States economy. The DJIA is one of the stock indices created by Dow & Jones Company founder and Wall Street Journal editor Charles Dow.

When the DJIA launched in 1896, it comprised only 12 US companies that were mainly engaged in industrial activities. Over the years, the index changed, so did the economy, and its composition now includes companies in other sectors such as technology, health, and retail.  The index changes when one or more components experience financial distress or when there is a significant shift in the economy and the change needs to be reflected in the composition.

 

Dow Jones Industrial Average (DJIA)

 

History of the Dow Jones Industrial Average

The DJIA was created on May 1896 by Charles Dow and his business associate Edward Jones. Two years earlier before the formation of the DJIA, Charles Dow composed his first stock average, Dow Jones Transportation Average (DJTA), which is the most recognized gauge in the United States transportation sector. The initial components of the DJIA comprised companies that were mainly industrial in nature such as gas, sugar, tobacco, railroads, and oil. The DJIA shows how 30 stocks of leading U.S. blue-chip companies performed during a standard trading session in NASDAQ and NYSE.

The index underwent several changes over the years, with the first being three months after its launch. In 1916, DJIA components were updated from 12 stocks to 20 components. They were then raised to 30 stocks in 1928, which remains the rule today. In 1932, eight stocks were removed and replaced with new components, including Coca-Cola and Procter & Gamble Company. During the Great Depression of the 1930s and the Great Recession of 2007/2008, there were significant changes in the DJIA stocks as companies collapsed, merged and others dropped from the index. 

The original 12 Dow Jones Industrial Stocks comprised the following:

  • American Tobacco
  • American Sugar
  • American Cotton Oil
  • Chicago Gas
  • General Electric
  • Distilling and cattle feeding
  • Laclede Gas
  • National Lead
  • North American
  • Tennessee Coal, Iron, and Railroad
  • U.S. Rubber
  • U.S. Leather

 

How the DJIA Works

The DJIA was created to measure the movements of the leading companies in the United States that were engaged in industrial activities. It uses the price-weighted index, meaning that stocks with a higher share price carry a greater weight in the index than stocks with a low share price. Initially, Dow calculated the averages by adding the stock prices of the 12 companies and dividing by 12. With the occurrence of events such as mergers and stock splits, the Dow divisor must be adjusted so that the value of the index does not get affected.

For example, if an index comprises three stocks with share prices of $10, $30 and $60, the highest priced stock represents 60% of the total value of all stocks. An increase in the highest-priced stock by 10% increases the value of the stock by $6 while a similar increase in the lowest-priced stock would increase its value by only $1. To calculate the DJIA of all the components, the 30 stocks are added together and divided by a Dow divisor, taking into account events such as stock splits, mergers, and acquisitions. According to the Wall Street Journal, the current divisor stands at 0.14523396877348 at the time of writing.

 

Components of the Dow Jones Industrial Average

There are no specific rules for a company to be included in the 30 company stocks in DJIA. However, for a company to appear in DJIA, it must account for a significant portion of the economic activities in the US. The company must also be listed in the NASDAQ or NYSE and be among the top performers in the market.

The DJIA makes numerous changes to its components to reflect the changes in the economy. The most recent changes occurred in March 2015 when Apple replaced AT & T, and in September 2017 when DowDuPont replaced DuPont. Only General Electric remains in DJIA since the original twelve components. As at September 30, 2017, the DJIA comprised the following companies:

  • 3M
  • American Express
  • Apple
  • Boeing
  • Caterpillar
  • Chevron
  • Cisco Systems
  • Coca-Cola
  • E I du Pont de Nemours
  • ExxonMobil
  • General Electric
  • Goldman Sachs
  • Home Depot
  • IBM
  • Intel
  • Johnson & Johnson
  • JPMorgan Chase
  • McDonald’s
  • Merck
  • Microsoft
  • Nike
  • Pfizer
  • Procter & Gamble
  • Travelers
  • UnitedHealth Group
  • United Technologies
  • Verizon
  • Visa
  • Wal-Mart
  • Walt Disney

 

Criticisms of the Dow Jones Industrial Average

Although the DJIA is one of the most important stock market activity trackers, there are some shortcomings associated with the index. With over 5,300 common stocks traded on NASDAQ and NYSE, the DJIA is not the best indicator of how the market is performing since it comprises only 30 stocks. A less than 1% representation of the market may, therefore, be misleading and may not portray the actual state of the economy.

Also, the use of a price-weighted index as opposed to a market-weighted index gives an advantage to some DJIA components than others. For example, a component with a share price of $120 would exert more than four times influence on the DJIA as a company with a stock price of $30 share price. Such an effect forces professional fund managers to use alternative indices like S&P to monitor the performance of the stock market.

 

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