What is the Dow Jones Industrial Average?
The Dow Jones Industrial Average is one of the most widely reported and monitored indicators of stock market performance. But how did it get there?
April 11, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
The Dow Jones Industrial Average (DJIA), also known as "The Dow Jones," or just "The Dow," is a stock market index that tracks the performance of 30 well-known blue-chip US companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.
Founded over a century ago, the DJIA is one of the most widely reported and monitored indicators of stock market performance in the U.S.
Origins of the Dow
The DJIA is the brainchild of Charles Henry Dow, who in 1882 founded the Dow and Jones Company with Edward Jones.
The Dow and Jones Company gathered financial news and published financial bulletins, including the one that would later become The Wall Street Journal.
A financial journalist himself, Charles Dow was looking for a way to track the overall activity and performance of the stock market. So in 1896 he came up with a list of 12 stocks that he believed best represented the overall market. He added up the prices of the 12 stocks and then divided them by 12.
This provided him with an average share price for these 12 stocks, and thus the Dow Jones Industrial Average was born.
The original Dow Jones companies were:
American Cotton Oil Company
American Sugar Company
American Tobacco Company
Chicago Gas Company
Distilling & Cattle Feeding Company
Laclede Gas Company
National Lead Company
North American Utility Company
Tennessee Coal & Iron
U.S. Leather Company (Preferred)
U.S. Rubber Company
International Business Machines
Johnson & Johnson
Procter & Gamble
Walgreens Boots Alliance
None of the original Dow Jones list of companies remain on the list, with the last remaining one, General Electric, exiting in 2018.
Criteria to fit in the Dow
The Dow Jones Industrial Company is maintained by the S&P Dow Jones Indices. A committee usually decides when to add a company to the index.
Unlike other indices, which often have stringent eligibility requirements, the DJIA does not have many specific rules for admission.
Companies hoping to get into the DJIA, however, must be large and respected and account for a significant portion of economic activity in the U.S. They must also be listed on the Nasdaq or the NYSE.
Additionally, companies must not be in the transportation or utilities sector; these are measured by other Dow Jones indexes such as the Dow Jones Transportation Average.
Changes in the DJIA components happen from time to time, but not very often. When they do, they are widely seen as a reflection of the emerging or declining impact of a specific company or type of company on the economy.
How is the Dow different from other indices?
The DJIA is one of several stock market indices that investors and analysts use to gauge market performance and activity. Two other major stock market indices are the S&P 500 and the Nasdaq Composite.
There are significant differences between these indices in terms of the number of constituents, sectors covered and eligibility criteria, among others.
The S&P 500, for example, tracks 500 of the largest publicly traded companies in the United States across a wide range of industries.
Meanwhile, the Nasdaq Composite tracks the stocks of more than 3,000 companies (mainly tech companies) currently listed on the Nasdaq Exchange.
The most significant difference between the DJIA and other stock market indices, however, is in the way that weights are assigned to individual companies in the indices.
Unlike most stock indices, including the S&P 500 and the Nasdaq Composite, which are weighted by some form of market capitalization, the DJIA is price-weighted (see more below).
How the Dow weighs companies in the index
In a price-weighted average, such as the one used by the DJIA, the prices of components are added together and then divided by the number of stocks used.
As a result, higher-priced stocks typically have a greater influence on the index than lower-priced stocks. So, a 10% change in the price of a stock going for $100 will have a much bigger impact than a 10% change in a stock going for $10.
Worth noting, however, is that the DJIA is calculated not by dividing the total prices by the total number of constituents, as Charles Dow did in the beginning, but by a special divisor.
The divisor is adjusted in the case of events such as mergers, stock splits and dividend payments. This helps to ensure continuity in the average.
What is the importance of the Dow, and why is it trusted?
The Dow Jones companies are all household names and are widely held by individual and institutional investors. Their fortunes have thus become synonymous with the fortunes of U.S. stocks in general.
So even though it consists of only 30 stocks, many analysts regard the DJIA (and its corresponding Dow Jones companies) as a reliable and trustworthy indicator of market activity and performance.
If you're an investor wanting to know if stocks are up or down, a look at the Dow Jones Industrial Average will give you a reasonably accurate picture.
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