The Dow Jones Industrial Average Explained: What Is the DJIA Index
Date Modified: 01/05/2024
The introduction of indices into the global markets continues to play a significant role as a simplified benchmark used to gauge the performance of any stock market segment or any economy. One of the earliest and most followed indices is the Dow Jones Industrial Average.
Main Points
- The Dow Jones Industrial Average (DJIA) is a stock market index.
- The DJIA measures the share prices of 30 blue-chip, public companies across various sectors, but excludes the transportation and utilities sectors.
- The DJIA works by a few principles including a price-weighted system, selection criteria, divisor, etc.
- The index has seen over 51 changes in composition since its creation in 1928 (until January 2024).
- At the inception of the Dow Jones Industrial Average, the Dow Divisor was just a simple average of 40.94. and has reduced drastically over time.
- Despite being the oldest and most followed indices to date, the Dow Jones Industrial Average still has some limitations and criticisms.
What Does the Dow Jones Industrial Average Mean?
The Dow Jones Industrial Average is a stock market index that tracks the collective daily changes in share prices of 30 US publicly-traded companies listed on the Nasdaq Stock Exchange or the New York Stock Exchange (NYSE). It is the second-oldest US market index, after the Dow Jones Transportation Average, which measures the share prices of 20 transportation companies, including airline companies and delivery services providers.
What Does the Dow Jones Industrial Average (DJIA) Measure?
In the early 1900s, the US was largely dominated by industrial companies, and the performance of these companies had a significant impact on the overall growth rate of the US economy. At such a pivotal time in history, the Dow Jones Industrial Average was introduced solidifying its role as a key indicator for the overall US economy.
Nowadays, the market has become more evolved as the Dow Jones Industrial Average measures the share prices of 30 blue-chip, publicly traded companies across various sectors, excluding the transportation and utilities sectors. These blue-chip companies are chosen to represent a broad range of American industries including the technology and entertainment sectors.
By tracking the combined changes in the share prices of companies across various sectors, the DJIA provides a snapshot of the overall performance of the US stock market and its economy as a whole.
How Does the Dow Jones Industrial Average (DJIA) Work?
The DJIA operates based on a few key principles:
- The DJIA calculates its value based on the absolute share price of 30 companies. This implies that stocks with higher share prices exert more influence on the overall value of the Index.
- The 30 companies in the index are chosen based on factors like size, industry representation, and financial health.
- The Index value is derived by tracking the daily changes in the share prices of all 30 companies and then dividing the total by a divisor.
- Given that stocks with higher share prices exert more weight on the index, a significant percentage move in a higher-priced stock can have a more substantial impact on the value of the index.
- Finally, the performance of the DJIA is reported in terms of points gained or lost compared to the previous closing value.
What Are the Criteria For a Company's Inclusion in the DJIA?
As economies evolve, new industries rise in prominence and others become less relevant. To reflect the ever-evolving economic landscape, the composition of the index is revised accordingly.
The companies comprising the DJIA are overseen by a specialized committee of five, which includes editors from the S&P DJIA Indices and The Wall Street Journal. They are responsible for reviewing and deciding which companies get added or excluded from the Dow Jones Industrial Average.
The index is not governed by strict rules but rather by general guidelines like:
- Large market capitalization
- Industry leaders of various sectors
- Sustained financial growth
- Investor interest
The primary criteria for inclusion in the index stipulate that each company must belong to the S&P 500, and should not belong to the transportation or utility sectors. So, once a company earns a spot in the DJIA, how exactly does its performance impact the index's overall value? The answer lies in its unique calculation methodology.
Calculating the DJIA: The Dow Divisor and Its Adjustments.
As a price-weighted index, the value of the Dow Jones Industrial Average is calculated using a price-weighted system which involves adding the share prices of 30 companies and dividing the sum by a divisor known as the Dow divisor. The performance of the DJIA is then reported in terms of points gained or lost.
What Is the Dow Divisor?
The Dow Divisor represents a numeric figure used to balance the influence of each stock within the Dow Jones Industrial Average. This means that every $1 change in any of the approximately 30 component stocks will move the index by the same number of points, regardless of the individual stock's price. This ensures the index accurately reflects the combined performance of its members without being skewed by any single stock fluctuations.
Adjustments Made to the Dow Divisor
At the inception of the Dow Jones Industrial Average in 1896, the Dow Divisor was just a simple average of the share prices of the first 12 companies it was composed of. But as time went on, companies merged, stocks got split, and dividends were paid out, all of which had to be accounted for, and of course, the simple average became inefficient.
To address the simple average issue and maintain the historical continuity of the DJIA index such that events do not alter the true numerical value of the DJIA, the Dow Divisor was created.
The Dow Divisor does change with events so that the value of the DJIA stays consistent in reflecting the overall performance of 30 companies' share prices.
For instance, the Dow Divisor was at 16.67 back in 1928. Following several changes, in 1986, the divisor fell below 1.0 for the first time. A variety of corporate events, notably stock splits and spinoffs, contributed to the decrease in the value of the Dow Divisor.
As of February 2024, the value of the Dow Divisor is 0.15172752595384.
Because the present Dow divisor has a value less than 1, it functions within the Dow Jones Industrial Average as a multiplier, not a divider.
What Is the Impact of Individual Stock Movements on the DJIA?
Using the most recent value of the Dow Divisor as of January 2024.
Divide 1 by the Dow Divisor: 1 / 0.15172752595384 ≈ 6.59
This calculation shows that a $1 change in any DJIA stock price move will result in an approximate 6.59-point move in the index. For example, if Microsoft's stock price increases by $1, the Dow Jones Industrial Average would be expected to rise by about 6.59 points.
How To Calculate the Overall Price Level of the DJIA:
Assume adding up the current stock prices of all 30 companies in the DJIA, amounts to a total of 5765.65. Divide the total stock price by the current divisor: (5765.65) / (0.15172752595384). This gives an index price level of approximately 38000.02.
How Is the Dow Divisor Adjusted Following a Stock Split?
Let's consider an index comprising 3 companies: A, B, and C, with an initial Divisor of 2. Initially, assuming Company A's stock price is $20, Company B's is $30, and Company C's is $40, the overall price level of the DJIA is calculated as (A + B + C)/2, resulting in $45. Now, if Company A conducts a 2-for-1 stock split, doubling its number of shares and reducing its stock price to $10 per share, we need to adjust the old Divisor of 2 to 1.77 to keep the index level unchanged. The calculation would be: $45 = ($20 + $30 + $40)/2 = ($10 + $30 + $40)/1.77.
History of the Dow Jones Industrial Average
In the 19th century, Charles Dow, Edward Jones, and Charles Bergstresser, founders of Dow Jones & Company – a major global business and financial news firm – established the DJIA (Dow Jones Industrial Average) along with several other indices representing various sectors of the US economy.
When the Dow Jones Industrial Average (DJIA) was created in 1896, Charles Dow selected 12 leading industrial stocks to be included in the initial index and the very first published average value of the DJIA was 40.94.
The first 12 constituents of the index include the American Cotton Oil Co., American Sugar Refining, American Tobacco Group, Chicago Gas Company, Distilling & Cattle Feeding Corp., General Electric Co., Laclede Gas Light, National Lead Industries, North American Utilities, Tennessee Coal and Iron Works, US Leather Inc., and US Rubber Manufacturing.
By 1928, the index expanded to include 30 components and has seen over 51 changes since then (and as of February 2024). Below are the first 30 stocks to be listed in the Dow Jones Industrial Average:
List of Companies in the First Dow 30
Allied Chemical Corp. |
American Can Inc. |
American Smelting Co. |
American Sugar |
American Tobacco Group |
Atlantic Refining Co. |
Bethlehem Steel Corp. |
Chrysler Motors |
General Electric Company |
General Motors Corporation Ltd. |
General Railway Signal Inc. |
Goodrich Tyres |
International Harvester Co. |
International Nickel Ltd. |
Mack Truck Manufacturing |
Nash Motors Automotive |
North American Company |
Paramount Publix Studios |
Postum Incorporated Beverages |
Radio Corporation of America |
Sears Roebuck & Company |
Standard Oil (N.J.) Refinery |
Texas Company Petroleum |
Texas Gulf Sulphur Mining |
Union Carbide Chemicals |
US Steel Corporation |
Victor Talking Machine Records |
Westinghouse Electric |
Woolworth Retail Chain |
Wright Aeronautical Engineering |
Just three months after this first Dow 30 was published, the first stock change occurred. Afterward, in 1932, the first large-scale change took place, with eight companies replaced at once.
As the DJIA components were reevaluated regularly, over time, the index became a bellwether of the US economy.
Timeline of Companies' Additions To and Removals From the Dow Jones Industrial Average
- In 1991, Martin Marietta Building Company replaced US Steel.
- In 1997, Travelers' Group Inc., Johnson & Johnson Pharmaceuticals, Hewlett-Packard Technology, and Walmart replaced Westinghouse Electric Corp., Bethlehem Steel Manufacturing, Texaco Energy, and Woolworths.
- In 1999, Chevron Corp., Goodyear Tire, Sears Roebuck & Co., and Union Carbide Corp. were replaced by SBC Communications company, Home Depot, Intel company and, Microsoft.
- In June 2018, Walgreens Boots Alliance was replaced by General Electric.
- In August 2020, the last update to the DJIA composition was announced. Pfizer, Raytheon Technologies, and ExxonMobil Corporation were replaced by Salesforce, Amgen, and Honeywell International Inc.
General Electric was a component of the DJIA the longest for over 120 years until 2018. It was the only company to stay on the DJIA with its original name since the very beginning.
List of Companies in Today's Dow 30 (As of February 2024)
Dow Inc. Chemicals |
||
Johnson & Johnson |
||
Microsoft Corp. |
||
Historical Milestones of the Dow Jones Industrial Average
DJIA has been a fixture in the financial world for over 120 years, witnessing both soaring highs and major dips. For 11 years, beginning from March 2009 to February 2020, the stock market enjoyed a record-breaking bull run. During this time, the Dow Jones Industrial Average (DJIA) kept reaching new highs.
Here are some of the most significant milestones that mark this index's journey:
Key Historic Highs of the Dow Jones Industrial Average
- March 15, 1933: Emerging from the Great Depression, the DJIA sees its largest one-day percentage gain of 15.34%.
- May 3, 2013: The DJIA surpassed 15,000 points for the first time.
- January 25, 2017: The DJIA surpassed 20,000 points for the first time.
- February 12, 2020: Dow reached its pre-covid high of 29,551.
- November 24, 2020: The DJIA rose from its Covid dip and surpassed its pre-pandemic high of 29,551.
- July 2021: The DJIA closes above 35,000 points for the first time.
- January 2024: The DJIA breaks 38,000 points, showcasing ongoing market confidence.
Key Historic Lows of the Dow Jones Industrial Average
- The Great Depression (1929-1933): The DJIA experienced a 90% loss in its value over just three years, reaching a record low of 41.22.
- Black Monday (Oct. 19, 1987): The DJIA experienced its worst single-day percentage drop of -22.61%.
- Great Recession (2007-2008): Amidst the recession triggered by subprime mortgage and credit crisis, the DJIA witnessed a 50% decline over a period of 18 months.
- COVID-19 Crash (March 2020): The DJIA experienced its worst single-day point drop of - 2,997.1 points and a total of approximately 11,000 points during the COVID-19 market crash.
Limitations and Criticisms of the Dow Jones Industrial Average?
Despite its significance as the oldest and most followed indices to date, the Dow Jones Industrial Average is not immune to limitations and criticisms.
- The Dow Jones Industrial Average (DJIA) represents only 30 large-cap US companies. Critics point out that this limited selection does not adequately represent the overall state of the US economy because it neglects companies of varying sizes and sectors.
- The DJIA was created in the early 1900s, reflecting the dominance of large industrial companies in the US at that time. However, today, the market has vastly evolved, driven by technological advancements and the advent of the internet, rendering the DJIA less representative of the broader economy.
- The DJIA's price-weighted methodology gives undue influence to the companies with higher stock prices, irrespective of their market size.
- The price-weighted system also means the index is impacted by individual stock price movements, not percentage changes. Hence, a minor fluctuation in a high-priced stock (with a small market cap) can hold the same weight as a significant shift in a high-market caped stock, distorting the overall picture.
DJIA Comparison with Other Major Indices
How Does the Dow Compare to the S&P 500?
The S&P 500 and DJIA rank as the world’s most-watched stock indices; however, the DJIA differs from the S&P 500 in the following ways:- The DJIA index was launched on May 26, 1896, S&P 500 was launched on March 4, 1957.
- The DJIA accounts for 30 major large-cap stocks except for transportation and utilities. whereas the S&P 500 tracks the largest 500 stocks in the US market.
- The DJIA index operates on a price-weighting system, in contrast to the S&P 500 which operates on a float market capitalization weighting system.
- The companies in the DJIA are selected by a committee of editors whereas the S&P 500 relies on a pre-defined set of rules and calculations to determine its constituents.
- The DJIA's value is derived by using a divisor, whereas the S&P 500's value is derived in comparison to a designated base year.
How Does DJIA Compare to the NASDAQ?
The Nasdaq Index and DJIA are two popular stock indices in the US; however, the DJIA differs from the Nasdaq in the following ways:
- The Dow Jones Industrial Index tracks 30 large-cap stocks except for transportation and utilities. while the Nasdaq tracks over 3000 stocks in the US market.
- The DJIA's reflect the collective performance of 30 major companies, rather than as individual stocks. In contrast, the NASDAQ is largely considered a reflection of the technology sector’s performance.
- The DJIA operates on a price-weighting system, while the Nasdaq is based on market capitalization.
- A committee of editors selects the stocks to be included in the DJIA, whereas the stocks in the Nasdaq include all stocks that meet specific criteria.
- The DJIA uses a divisor; the Nasdaq is calculated against a base market value.
Frequently Asked Questions
Can I trade the Dow Jones Industrial Average?
You can gain exposure to the DJIA on Plus500 by trading DJIA CFD derivative known as USA 30 or US30. You can also trade the DJIA exchange-traded fund (ETF) CFDs or its individual shares CFDs without owning any of the shares that comprise the index.
What does the Dow Jones Industrial Average tell us?
The Dow Jones Industrial Average acts as an indicator of the US stock market. It tells the overall sentiment of investors towards the US economy.
Why is it called the Dow Jones Industrial Average?
It is easy to confuse Dow Jones Industrial Average as a single person, but the DJIA owes its name to the creators of the index namely Charles Dow and Edward Jones.
How are the Dow Jones Industrials doing today?
The Dow Jones Industrial Average has been on an uptrend since October 2023. As of 2nd of February 2024, it is trading above 38,000 points.
Conclusion
From its humble beginnings in 1896 with just 12 companies, the Dow Jones Industrial Average has since been a global icon, serving as a benchmark for investors, analysts, and the public alike. Despite its limitations, the DJIA continues to be one of the most closely monitored indices, providing valuable insights into the constantly evolving global market.
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