The Dow Jones Industrial Average (DJIA)

What is the Dow Jones Industrial Average?

The Dow Jones Industrial Average (also known as the Dow) is a major stock market index that tracks thirty of the largest public-owned blue-chip companies in the US that trade on the New York Stock Exchange (NYSE) and the NASDAQ. The name ‘Dow Jones’ was coined from the combination of the names of Charles Dow, the creator of the index in 1896, and his business partner Edward Jones.

The Dow is the most followed equity index in the US stock market, however, some experts consider it to be an inadequate representation of the US stock market, generally, since it only includes 30 large-cap companies unlike the S&P 500 Index or Russell 3000. The Dow is also not weighted by market capitalization and does not use weighted arithmetic mean. Although, to many investors, the performance of the Dow Jones reflects the outcome of the stock market and economy at large.

Understanding DJIA

The Dow Jones Industrial Average (DJIA) is one of the oldest indexes in the world. It is also the second-oldest US market index after the Dow Jones Transportation Average which includes 20 stocks of railroad and trucking companies.  It is commonly known as a collection of price-weighted blue-chip companies including Exxon Mobil Corporation, Microsoft Corporation, and Walt Disney. These companies are known for their consistently stable earnings.

Historically, the Dow Jones included 12 industrial companies, hence the “industrial” in the name. Over time, the index expanded its operations to other industries like tobacco, cotton, sugar, oil, gas, and railroads.

How to calculate the DJIA

In calculating the index, its value is represented by the sum of the price of one share of stock for each component company divided by a factor that changes whenever one stock of the component stocks has a stock dividend or stock split, in order to generate a consistent value for the index. The divisor is approximately 0.1458, the value of the index is about 6.859 times larger than the sum of the component prices.

Usually, stocks with higher share prices have greater weight in the index. A higher percentage move in a higher-proceed component will greatly impact the final calculated value. At the inception of the DJIA, the average was calculated by adding up the prices of the twelve component stocks and dividing by twelve. Eventually, a few additions and subtractions were added to the calculation such as stock splits and mergers. As a result of this, the Dow Divisor was created – a predetermined constant that can be used to determine the effect of a one-point move in any of the 30 stocks included in the Dow. The Dow Divisor can be changed is the need arises.

DJIA listed companies