What is the Dow Jones Industrial Average?

by MB on February 19, 2008

With Bank of America and Chevron entering the Dow Jones Industrial average today, I thought it would be a good time to discuss exactly what this closely watched stock market indicator is, and how it is configured and calculated.

History

The Dow Jones Industrial Average (DJIA) was originally, as its name implies, an index of twelve of the largest industrial stocks trading on the New York Stock Exchange.  The list was compiled by Charles Dow, an editor at the Wall Street Journal, and was first published on May 26, 1896. 

The first list contained such venerable names as: American Cotton Oil Company, Distilling & Cattle Feeding Company, and National Lead Company.  Of the original twelve, only one, General Electric, is still a member of the DJIA.  The rest were either later dropped from the list, acquired, or split up.

The average was originally computed by totaling its constituent stock prices and dividing by the number of companies in the index.  Incidentally, the first day closing Dow Average was 40.94.

The average was increased to twenty stock in 1916, and was again increased to thirty stocks in 1928, which is the number of stocks that make up the average today.  A quick note on the debilitating effect the great depression had on stocks:  The DJIA peaked at 381.17 on September 3, 1929.  Three years later, it bottomed on an intra-day low of 40.56 – less than where it started 36 years before!

Structure

As mentioned, the DJIA now consists of 30 stocks, many of which cannot be termed “industrial”.  Here are the 30 Dow stocks as of February 19, 2008:

3M
Alcoa
American Express
American International Group
AT&T
Bank of America
Boeing
Caterpillar
Chevron Corporation
Citigroup
Coca-Cola
DuPont
ExxonMobil
General Electric
General Motors
Hewlett-Packard
Home Depot
Intel
IBM
Johnson & Johnson
JPMorgan Chase
McDonald’s
Merck
Microsoft
Pfizer
Procter & Gamble
United Technologies Corporation
Verizon Communications
Wal-Mart
Walt Disney

Although these are large US corporations, many feel that a broader average – such as the S&P 500, is more representative of the US Stock market.

Component Weightings

The DJIA is a price-weighted average, meaning that stocks with a higher share price have a much greater influence on the overall average than a lower priced component.  For instance, a move in IBM, at $106 per share has a much greater influence on the DJIA than a move in Microsoft at $28 per share, even if Microsoft were to move a greater percentage basis.  Contrast this with the S&P 500 which is weighted by market capitalization.

Average Calculation

The DJIA is calculated by summing the prices of all of its components, then dividing the total by a divisor.  The divisor changes periodically as companies are replaced, shares of components split, or dividends are paid.  This divisor is designed to “smooth out” events, so that the average has continuity over time.  As of today – February 19, 2008 – the divisor is 0.123017848. 

Leave a Comment

Previous post:

Next post: