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Understanding the Dow Jones Index

Apr 26, 2025

Lecture Notes: How Does the Dow Jones Work?

Key Takeaways

  • Dow Jones Industrial Average (DJIA): A stock index of 30 blue-chip industrial and financial companies in the U.S.
  • Media Usage: Barometer for the broader stock market and economy.
  • Limited Scope: More limited than S&P 500; only 30 stocks.
  • Price-Weighted Index: Uses a divisor to normalize components; does not account for market capitalization changes.

The Dow Jones and the Broader Market

  • Three major U.S. indexes: Nasdaq Composite, DJIA, S&P 500.
  • DJIA is widely recognized but S&P 500 is often preferred for broader market insights.

History of the DJIA

  • Founded in 1882 by Charles Dow, Edward Jones, Charles Bergstresser.
  • Originally focused on transportation; evolved to cover industrials in 1896.
  • Procter & Gamble holds the longest tenure in the index.
  • Recent changes: Nvidia and Sherwin-Williams added in November 2024.

How the DJIA Value Is Calculated

  • Originally simple averages; modern calculation uses the Dow divisor.
  • Divisor adjusts for stock splits, ensuring accurate reflection of company value.

How Does the Dow Divisor Work?

  • Current stock prices of the 30 companies divided by Dow divisor.
  • Adjustments ensure splits do not artificially lower the index value.

The DJIA as a Dollar Value

  • Stock price changes affect DJIA based on divisor.
  • Example: A $5 rise in Walmart’s stock impacts DJIA by 34.01 points using divisor.

Weighing the Index

  • Price-Weighted Method: Ranks companies by share prices.
  • Drawback: Does not account for percentage impact differences among stocks.

The Downside of the Dow

  • Reflects only U.S.-based industrial companies; lacks global and industry diversity.
  • Technological and global market changes render it less relevant as a sole indicator.

The Dow and the Economy

  • Historical significance offers comparative analysis over time.
  • Tracks major American industries, excluding utilities and transportation.
  • Significant media coverage influences perception of economic state.

Which Stock Market Index Is Important to Follow?

  • S&P 500 recommended for broader market view.
  • MSCI All Country World Index preferred for international stocks.

Are Companies Chosen for the S&P 500 the Same Way as the Dow?

  • S&P 500 has formal criteria; reviewed quarterly.

The Bottom Line

  • DJIA is a historic marker but limited in representing modern economic dynamics.
  • High media attention maintains its status as an economic indicator.