May 19, 2023
Even for those new to the financial world, the Dow Jones Industrial Average is something that many have certainly heard of, though might not fully understand what it is. Referenced almost daily on television news and radio updates, people may have a loose understanding of it without being able to explain it to someone else.
Simply put, The Dow Jones Industrial Average (DJIA) is an index or way of measuring the value of 30 large, publicly-owned blue-chip companies being actively traded on the New York Stock Exchange (NYSE) and Nasdaq. Named after Charles Dow, who was responsible for creating the tracking index in 1896, along with his business partner, Edward Jones, the index is often used as a pulse for the larger market health. The second oldest market index, the group was created to be a market thermometer that makes it easier to look at one source instead of multiple sources to assess the status of the market. The stocks that are chosen for the Dow have proven consistent value through the ups and downs of the market, so if the Dow finishes the trading day higher, individual investors can infer that the overall market is relatively healthy. The opposite is true as well: When the Dow ends the trading day lower, shareholders can infer that the market is down.
A retail shareholder that is new to investing might think it makes good sense to buy shares in the DJIA, which can be confusing, since the DJIA has a ticker symbol (DJI) even though the Dow itself isn’t tradable. Investors could choose to invest in one or some of the 30 companies that make up the Dow. Or individual investors could purchase specific ETFs and mutual funds that are designed to mirror the Dow’s makeup.
The companies that are currently in the Dow 30 have been selected by a committee of editors at The Wall Street Journal. A hefty responsibility, the committee has to make decisions about a company based on its reputation, its sustained growth and the size of its market capitalization. If a company has significant market capitalization, it is a reference to the value that is of the outstanding common shares owned by stockholders and an indicator that it has reached a certain stage of corporate development. The only real stipulation on whether a company can be a part of the Dow or not is that it is a non-transportation or non-utility company in the S&P 500 (publicly traded). Generally the financial performance of a company plays a large role in whether or not a company stays in the Dow, and the trend has been to favor technology and healthcare companies. In a recent interview, WSJ Editor Mike Prestbo said that they try to select a group that represents a composite of the market.
Determining the value of the DJIA is not simply an average of the stock price of each of its members, though in the beginning it was. Charles Dow calculated the average by adding the prices of the 12 Dow stocks and dividing them by 12 to determine a simple average. As the number of stocks in the DJIA grew to 30, the manner to establish the value became more nuanced. Stocks with higher share costs are assigned greater weight in the index. So a larger percentage move in a higher-priced asset will have a greater impact on the final calculated value. The Dow Divisor is a number that factors in stock splits and stock dividends to become a universal way to understand the effect of a one-point move in any of the 30 stocks that make up the Dow.
Though the DJIA is a tool that is a useful thermometer of the market, it is subject to change and the whims of the market. As with any stock information, it is strongly recommended that you seek out an experienced and knowledgeable financial advisor to guide you through the investing landscape.
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