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.