Dow Jones Industrial Average ( DJIA ) or Dow Index
You have Likely heard someone on the news say something like, The Dow is up 90 points, but what if they mean?
They are talking about the Dow Jones Industrial Average ( DJIA ) or Dow. The Dow is an average of the price of a selected group of stocks, also known as an index.
Rather than a micro-look at just a single company’s performance, an index helps investors see the overall performance of the broader market.
The Dow was first created by financial journalist Charles dow in 1896 and it included just 12 companies.
There is a list of original companies when dow jones Industrial Average is created.
- American Cotton Oil
- Lac Lede Gas
- American Sugar
- National Lead
- American Tabacco
- North American
- Chicago Gas
- Tennessee Coal & Iron
- Distilling & Cattle Feeding
- U.S. Leather
- General Electric
- U.S. Rubber
Over time, the index grew and as of 2022, the dow includes 30 companies from nine different sectors or major parts of the economy.
The sector Breakdown is as follows –
- Consumer Services
- Health Care
- Consumer Goods
- Basic Materials
The 30 companies in the Dow are selected because they are considered the market leader in their sectors.
If an individual company is underperforming the overall economy, a committee may consider replacing it with other.
For example, in 2018, General Electric the last remaining original company in the Dow had been underperforming its sector for several years.
So General Electric was removed to make room for the drugstore chain, Walgreens.
Including major companies in different sectors is meant to point a picture of the overall market and signal to investors, if a portion of the economy is weakening.
Keep in mind that the stock market is not the economy but historically, the Dow has generally tracked the U.S. gross domestic product, an overall measure of economic activity.
While the Dow is meant to provide a snapshot of the stock market’s performance, certain features may skew its outlook.
First, the Dow’s 30 companies are a pretty narrow slice of the U.S. stock market, which contains thousands of publicly traded companies. Having such a small view could distort what the broad market is signaling.
Next, the Dow Jones is price-weighted, this means companies with a higher share price have a larger effect on the overage, regardless of the company’s actual size.
For Example, Goldman Sachs was trading around $177 on May 12, 2020. While Pfizer was around $37 dollars. However, Pfizer’s market capitalization was $207 billion compared to Goldman’s $60 billion.
This means that even though Pfizer is over three times larger by market cap, Goldman Sachs carries more weight in the index based on its share price.
Because of this, some investors feel the Dow is a less precise way to monitor the market and believe that another index S&P 500 is a more accurate representation.
The S&P 500 features 500 companies from every sector, so it’s a sampling from a wider base. In addition, the S&P 500 is market cap weighted instead of stock price-weighted.
This means larger companies with a higher market cap have more influence over the index than smaller companies.
The difference between price and market cap weighting was obvious in early march 2019 when Boeing’s shares dropped 14% following its grounding of the 737 max.
Because Boeing had the highest share price in the Dow at the time, its fall dragged the Dow Jones with it. meanwhile, the S&P 500 rose because the broader market was performing well.
So while Dow Jones can serve as a quick gauge of the U.S. stock market, it can’t a more complete picture.