What is the Dow Jones Industrial Average (DJIA)?
As you read and learn about the stock market, one term you’ll come across often is Dow Jones Industrial Average, also commonly called the Dow or DJIA. The DJIA is a market index designed to give a real-time view of the state of the market at a glance.
However, unlike other indexes, the Dow only measures a select few companies — only 30 to be exact. Although the low component count and method of weighting has led to some criticism, the index is still a leading benchmark on Wall Street today.
So, what exactly is the Dow Jones Industrial Average, and how can you use it to make money in the market?
What Is the Dow Jones Industrial Average?
As mentioned above, the index is a market average designed to give you a look at what’s happening in the market at a glance. First brought to the public in 1884, the index was just one of several created by Charles Dow, Edward Jones, and Charles Bergstresser.
Originally, the index was designed to track blue chip railroad stocks. However, it has grown to cover U.S. stocks of various sectors that are meaningful to the United States economy over the years.
The Dow is a price-weighted index, which is a unique approach to averaging that some suggest creates an inaccurate depiction of what’s happening in the market. The reason lies in how a price-weighted index works.
Price-weighted indexes give greater weight, or value, to higher priced stocks when it comes to their contribution to the index value and changes in index as a whole. This is different from what most investors are generally looking for — the price of the stock doesn’t generally matter, what matters is the percentage of movement.
For example, let’s say you’re tracking two stocks: ABC, which is trading at $100 per share, and DEF, which is trading at $10 per share. ABC gains $1 while DEF loses $1. In a price-weighted average, the two wash themselves out for no change. In reality, a $1 change is a minor adjustment for a $100 stock and a big change for a $10 stock.
Also, the Dow doesn’t adjust for stock splits or dividends. While some argue this is a disadvantage, others say this creates an accurate depiction of the average price of the index over time without splits and dividend payments skewing the data.
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History of the Dow Jones Industrial Average
One of the oldest indexes still used today, the Dow Jones Industrial Average got its start in 1884 as an average of 11 stocks, although there is a common misconception that it got its start in 1886 as an average of 12 stocks. The index was being conceptualized as early as 1882, when Dow Jones & Company was first founded.
The index was first published in The Customer’s Afternoon Letter, a daily financial bulletin that eventually became The Wall Street Journal. The original index created by Dow, Jones, and Bergstresser was made up of nine railroad stocks and two industrial stocks.
By 1886, the number of stocks had grown to 14 before being cut back to 12 on January 2, 1886, which many consider the original 12 companies on the Dow. Of those 12 companies, 11 of them were industrial stocks, with only one railroad stock left on the list.
Over time, the number of companies included in the Dow grew, but not by much, reaching 30 components in 1928, the same average number it has maintained for decades and continues to maintain today.
The component count on the Dow isn’t the only thing that’s changed over time. Today it covers a more diverse group of stocks than it has in the past. While industrials were a major determining factor in the state of the U.S. economy when the index was first created, that has changed quite a bit over time.
Today the Dow covers stocks in tech, health care, financial services, transportation, and consumer goods.
Ownership of the index has changed over time as well. Of course, it was originally owned by its creators, Dow Jones & Company, but today the index is part of one of the largest financial companies in the world, S&P Dow Jones Indices LLC, a company created in 2011 as the result of a merger between S&P Global, CME Group, and News Corp.
Throughout history, the value of the Dow has proved to be an important economic measure, as the index tends to rise during positive economic conditions and fall during economic hardships.
In the mid-1880s, the index stood at a value of around 67 and was on a tear for the top, reaching a peak value of 78.38 in 1890. Unfortunately, in 1896, a depression struck the U.S., driving the index down to its all-time low of 28.48.
From there, the index began to recover, but also saw significant declines during market panics in 1901 and 1907, both of which hit the U.S. stock market exceptionally hard. The index continued on relatively short runs upward followed by relatively short runs downward for some time.
That is, until 1920, when the index went on a prolonged bull run that would last until 1929, with the Dow climbing from a value of 73 to 381 in that time frame. This led to that time period being called the Roaring ‘20s. In September 1929, the Roaring 20s came to a halt when the bottom fell out of the market in a two-month period that would send the Dow back down to 198.69.
Nonetheless, the Dow would recover and continue on its path of ebbs and flows, ultimately breaking the 1,000 mark in 1972. By January 1987, the index smashed through 2,000 as it maintained a relatively steady upward path. It would continue on its general path upward with economic hardship-related declines here and there before breaking its next big milestone in 1993, when it broke through the 3,000 level.
By July 1997, the Dow had climbed to 9,000. It broke through 10,000 in 1999 as excitement around technological innovation led to more power consumption and more opportunities in the market.
Then, on September 17, 2001, the Dow fell more than 7% when Wall Street reopened for trade for the first time since the terrorist attack on the World Trade Center. The move proved to be short-term, with the Dow regaining much of the losses and closing back above 10,000 by the end of the year.
The excitement surrounding the recovery would be short lived, with the index falling to 7,286 in September 2002 as the dot-com bubble popped. Nonetheless, by the end of 2003, the index made its way back over 10,000 and was trending up, ultimately reaching a high of 14,198.10 in October 2007, just before the start of the Great Recession.
Stocks in the Dow Jones Industrial Average
As mentioned above, the Dow has undergone several changes throughout its long history, some to its ownership, and others to its components. In fact, today the index doesn’t include a single one of the original stocks that were listed.
The company with the longest run on the DJIA was General Electric, first added to the index in May 1896 and maintaining its listing continuously from 1907 until mid-2018.
Current Components of the Index
The current components of the index, commonly referred to as the Dow 30, include:
|Company Name||Ticker Symbol||Year Added|
|3M Co.||NYSE: MMM||1976|
|American Express Company||NYSE: AXP||1982|
|Amgen, Inc.||NASDAQ: AMGN||2020|
|Apple Inc.||NASDAQ: AAPL||2015|
|Boeing Co||NYSE: BA||1987|
|Caterpillar Inc.||NYSE: CAT||1991|
|Chevron Corporation||NYSE: CVX||2008|
|Cisco Systems Inc.||NASDAQ: CSCO||2009|
|The Coca-Cola Company||NYSE: KO||1987|
|Dow Inc.||NYSE: DOW||2019|
|Goldman Sachs Group Inc.||NYSE: GS||2013|
|The Home Depot Inc.||NYSE: HD||1999|
|Honeywell International Inc.||NASDAQ: HON||2020|
|Intel Corporation||NASDAQ: INTC||1999|
|Johnson & Johnson||NYSE: JNJ||1997|
|JPMorgan Chase & Co.||NYSE: JPM||1991|
|McDonald’s Corp||NYSE: MCD||1985|
|Merck & Co Inc.||NYSE: MRK||1979|
|Microsoft Corporation||NASDAQ: MSFT||1999|
|Nike Inc.||NYSE: NKE||2013|
|Procter & Gamble Co||NYSE: PG||1932|
|Salesforce.com Inc.||NYSE: CRM||2020|
|Travelers Companies Inc.||NYSE: TRV||2009|
|UnitedHealth Group Inc.||NYSE: UNH||2012|
|Verizon Communications Inc.||NYSE: VZ||2004|
|Visa Inc.||NYSE: V||2013|
|Walgreens Boots Alliance Inc.||NASDAQ: WBA||2018|
|Walmart Inc.||NYSE: WMT||1997|
|Walt Disney Co.||NYSE: DIS||1991|
How to Use the Dow Jones Industrial Average
There are several ways the Dow can be used for both investors and economists. Some of the most common uses of the index include:
1. As a Benchmark
The Dow is one of the three most used benchmark market indexes in the U.S., with the other two being the S&P 500 index and the Nasdaq composite index. Benchmarks are a great way to determine how well or how poorly your own investment portfolio or a single investment is performing in relation to the overall market.
If your portfolio’s returns outpace those of the Dow, it’s reasonable to say you’re doing well, and your investment strategy is one worth using. On the other hand, if you’re underperforming the index, it may be a good idea to look into your portfolio. You can compare each holding to the index to determine which assets are holding you back, and either get rid of them or adjust your strategy if you notice a pattern emerging.
2. As an Investment
The Dow also offers a compelling way to go about investing. There are several exchange-traded funds (ETFs), and index funds on the market that are centered around the DJIA. These funds pool money from a large group of investors and invest in the components of the Dow in an attempt to recreate its returns.
By investing in these funds, you’ll gain exposure to all 30 companies listed on the Dow with an allocation strategy made to mirror the index. As a result, when the Dow rises your portfolio will experience similar gains, and when it falls you’ll realize similar losses.
3. As a Performance Indicator
The Dow is also a great indicator of the U.S. stock market’s performance, especially in terms of large-cap, established companies. After all, the Dow is made up of 30 of the largest companies listed on the U.S. stock market.
4. For Economic and Market Monitoring
The U.S. economy is closely correlated with the Dow’s movement, meaning when the economy is doing well, the index tends to rise, and when economic concerns arise, the index declines.
It makes sense too.
When the economy is doing well, consumers experience growth in lending and spending, both of which result in growth of corporate profits. On the other hand, when economic concerns are on the horizon, spending and lending slow, putting dents in both the top and bottom lines for corporations.
As a result, economists often use the index as a way to gauge the state of the U.S. economy, with each economic phase represented by trends in the DJIA chart.
5. As a Measure of Historical Performance
Finally, the Dow is the longest-lived market index that’s still in use today. History provides a rich source of economic information!
Using the index, you can measure correlations between economic cycles and the stock market that go back more than a century, using a price-weighted average that isn’t skewed by dividend payments and share splits.
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Criticism of the Dow Jones Industrial Average
The Dow is the subject of plenty of praise. But the stock market is a battle between the bears and the bulls, and the prices of stocks aren’t the only battlegrounds. The index is hotly debated between those who believe it offers an accurate depiction of historical trends in the market and economy, and those who don’t.
Critics of the Dow have the following arguments:
Not Adjusted for Stock Splits or Dividends
When a stock split happens, whether traditional or reverse, the price of a share of stock changes because the value of each share changes.
For example, say ABC is trading at $1,000 per share and the company decides that the high price of the stock is a hindrance to new, smaller investors. To attract a larger audience, the company may execute a traditional stock split at a rate of 5 to 1. That means every single share on the market pre-split becomes five shares post-split, each trading at $200, or one-fifth the pre-split price.
In a reverse split, a company —often one that’s struggling — will consolidate shares to increase the stock price per share, making it more attractive to institutional investors or to simply comply with listing standards of the exchange they’re listed on.
These moves are cosmetic, and not calculated into the Dow’s average. Some argue that this means the value of the Dow is overinflated.
Price Over Percentage
For the average investor, price isn’t nearly as important as percentage gains. Think about it, would you rather experience a $1 gain on a $100 stock or a $1 gain on a $10 stock? Of course, you want to own the $10 stock in this case because it climbed 10% while the $100 stock was only up 1%. That’s a huge difference.
However, as a price-weighted index, the opposite is true for the Dow. Both of these moves would have equal significance in the calculation of the average, a characteristic that many believe adds further uncertainty about the validity of the average itself.
Finally, the Dow’s critics also argue that it’s not an accurate depiction of the stock market as a whole, as massive sections of the market lack representation in the index. There are no small- or mid-cap companies listed; all the Dow’s components are massive blue chip companies, which may not represent the fortunes of all businesses on the market — and some suggest doesn’t even accurately represent the broader universe of large-cap stocks.
Also, the Dow has diversified over the years, adding companies in health care, technology, and other more modern industries, but even these are vast sectors with several important subsectors. With only 30 components, some argue it is impossible for the index to build an accurate representation of many of the categories it purports to track.
Sure, there are critics who would prefer using a more diverse index that calculates its figures differently, but the fact remains the Dow is popular for many reasons.
There are many uses for the index, and despite its critics, historically it has proven to be one of the most accurate measures of both the market and the U.S. economy for more than a century. The Dow Jones Industrial Average be used not only for research, but as an investment model in and of itself.