The Dow Jones Industrial Average, also known as the DJIA or simply the Dow, comes up often in the news these days. For one, our president loves to tweet about it. And the index has recorded some major highs and lows in just the past couple of years.
While you probably get the sense that the Dow’s performance is important, unless you’re a finance or stock market buff, you might not know exactly why. Here’s what you need to know about how the Dow Jones works and what its numbers mean.
What Is The Dow Jones Industrial Average?
The Dow is a market index of the largest publicly traded companies in the U.S., used to gauge the market’s overall performance. It was created in 1896 by Charles Dow, an American journalist who with partner Edward Jones founded Dow Jones & Company, a publishing and financial information firm. The Wall Street Journal was started by the company.
At the time, the DJIA was made up of just 12 companies. Dow tracked their stock prices each day, added them up and dividing by 12 to get his average. As the average moved up or down, investors could get a sense of how the stock market as a whole did that day.
“At its inception, the firms included in the index were industrial giants, primarily because these firms were the predominant publicly traded firms at the index’s founding,” explained Riley Adams, a certified public accountant, senior financial analyst at Entergy and the owner of personal finance blog Young and the Invested.
Since then, the companies included in the Dow Jones average have changed quite a bit, and the list has grown to 30.
The Dow 30
Today, the Dow includes tech firms, health companies, financial institutions and other major corporations outside the industrial sector. “Essentially, as the composition of the economy has changed over time, so too has the Dow,” Adams said.
Here’s a look at the companies that now make up the DJIA (it’s important to note that this list changes often):
American Express (AXP)
DowDuPont Inc. (DWDP)
Exxon Mobil (XOM)
Goldman Sachs (GS)
Home Depot (HD)
Johnson & Johnson (JNJ)
JPMorgan Chase (JPM)
Procter & Gamble (PG)
Travelers Companies Inc. (TRV)
United Health (UNH)
United Technologies (UTX)
Walgreens Boots Alliance (WBA)
Walt Disney (DIS)
How The Dow Jones Industrial Average Is Calculated
The DJIA is calculated by adding up the prices of one share from each of the 30 companies, and then dividing the sum by the “Dow Divisor.” The Divisor was created to help account for stock splits and other changes to Dow companies so that there’s continuity to the average over time.
The Dow Jones is different from other major market indices because it’s the only one that’s price-weighted. That means that lower-priced stocks have a much lower weight in the average than higher-priced stocks, according to Robert R. Johnson, professor of finance for the Heider College of Business at Creighton University in Nebraska.
For example, Boeing represents 10.05% of the DJIA, while it only represents 0.85% of the S&P 500 (another popular market index), Johnson said. So the recent hit to Boeing’s stock price due to issues with its 737 Max 8 planes means that the DJIA was affected much more than the S&P 500.
Today, most indexes ― including the S&P 500 ― are market cap-weighted; the companies are weighted according to the total market value of their outstanding shares rather than the price of a single share.
How Much Should You Really Care About The Dow?
Since the companies on the Dow 30 are all huge entities with a large market capitalization, many people still rely on the Dow to tell them how the market is performing day to day. However, it may not be the best indicator anymore, given how few stocks it tracks compared to the size of today’s market. More than 2,800 companies are traded on the New York Stock Exchange alone, which range from major blue chip to smaller and newer companies.
“Today, as many more companies have gone public, it does not represent the publicly traded economy as well as other indices,” Adams said. For example, the S&P 500 tracks the 500 largest publicly traded companies in the U.S., while the Russell 2,000 follows the 2,000 largest.
Even so, “the Dow has remained stalwart in people’s minds as the market index to follow for understanding how the market is trading,” Adams said.
So while you might look to the Dow to get a snapshot of the stock market’s health, take it with a grain of salt. It’s not the only index out there, and not necessarily the most reliable.