Dow Jones Industrial Average (DJIA)

The stock market indicator that tracks 30 of the most significant, publicly-traded blue-chip businesses and indicates the overall state of the U.S economy

Rohan Arora

Reviewed by

Rohan Arora

Expertise: Investment Banking | Private Equity


October 13, 2023

What Is the Dow Jones Industrial Average (DJIA)?

The Dow Jones Industrial Average (DJIA), sometimes referred to as the Dow 30, is an indicator of the stock market that keeps track of 30 significant, publicly-traded blue-chip businesses that trade on the NYSE and Nasdaq. 

It is named after Charles Dow, who, together with his business partner Edward Jones, established the index in 1896.

The Dow Jones Transportation Average (DJTA) was the first U.S. market index, and the second was the DJIA. This was created to act as a stand-in for the state of the overall U.S. economy. 

It is sometimes known as "the Dow," one of the world's most closely followed stock market indices. Despite the diversity of the firms included in the Dow, each may be categorized as a blue-chip company with steadily rising earnings.

Only 12 firms were there when the index was first introduced in 1896. Railroads, cotton, gas, sugar, tobacco, and oil were among the businesses that were predominantly in the industrial sector.

Early in the 20th century, industrial firms' performance was frequently correlated with the pace of economic expansion. That solidified the connection between the performance of the Dow and the state of the economy as a whole. 

Even now, many investors believe that a high-performing Dow signals a healthy economy (while a weak-performing Dow indicates a slowing economy).

The index's makeup evolves along with the economy throughout time. When a firm ceases to be relevant to contemporary economic developments, it may lose its spot in the Dow and be replaced with a new name that more accurately represents the change.

A corporation with significant market capitalization losses due to financial difficulties could be dropped from the Dow. By dividing the number of shares outstanding by the stock price, a method known as market capitalization is used to calculate a company's value.

The index gives stocks with higher share prices more weight. Therefore, a higher percentage change in a more expensive component will have a bigger effect on the total determined value. 

Charles Dow determined the average at the Dow's debut by summing the values of the twelve stocks that made up the Dow and dividing by twelve. 

A simple average was the outcome. The index has undergone additions and deletions throughout time due to stock splits and mergers that needed to be considered. A straightforward mean computation was now illogical.

Key Takeaways

  • The Dow Jones Industrial Average (DJIA) is a stock market indicator that tracks 30 significant publicly-traded blue-chip companies on the NYSE and Nasdaq, named after Charles Dow and Edward Jones.
  • The DJIA's history began with Charles Dow creating the Dow Jones Transportation Average (DJTA) and later developing the DJIA as a stand-in for the overall U.S. economy.
  • The DJIA's composition evolves over time, with companies being replaced to reflect contemporary economic developments and relevant industries.
  • The DJIA is a price-weighted index, criticized for its limitations as it only includes 30 large-cap U.S. corporations and may not adequately represent the economy compared to the S&P 500.
  • The Dow Divisor is used to calculate the DJIA, ensuring that a one-point change in any of the 30 stocks has an equal impact on the index. Companies' market capitalization is not considered in the calculation.

Some Background about the Dow Jones & Company

Two of the three persons who started Dow Jones & Company in 1882 were named Dow Jones, not one. The third founder of the business was Charles Bergstresser. Charles Dow was the Dow in Dow Jones, and Edward Jones was the Jones. 

They later founded The Wall Street Journal, one of the most significant financial periodicals in the world, in 1889.

Dow was renowned for his aptitude for illuminating complex financial news for the general public. He thought there needed to be a straightforward benchmark for investors to know whether the stock market was increasing or falling. 

Dow selected several firms with an industrial focus for the first index; the initially reported average was 40.94.

Charles Dow also thought it was feasible to forecast changes in the stock market based on changes in the prices of various stock classes. The Dow Theory states that a comparable rising trend in transportation equities should support an upward trend in industrial companies. 

To better predict which way "industrial stocks" or "transportation stocks" were heading, Charles Dow developed a number of market averages.

Dow Jones & Company was still a significant financial news source as of 2022. MarketWatch, Barron's, and The Wall Street Journal were among its publications. Additionally, these financial news sources remained remarkably independent of News Corp.

On the other hand, the Dow Jones Averages that Dow Jones & Company originally founded are no longer under its direct control. S&P Dow Jones Indices LLC, a partnership between S&P Global and the CME Group, is the company that owns the Dow Jones Averages.

History of the Dow Jones Industrial Average

The history behind the concept is: Charles Dow and his business partner Edward Jones founded the DJIA in May 1896. 

Before the Dow Jones Industrial Average was created two years prior, Charles Dow created his first stock index, the Dow Jones Transportation Average (DJTA), the most widely used indicator of the U.S. transportation industry. 

It displays the performance of 30 equities from top blue-chip American corporations.

Over time, the index has undergone several adjustments. The DJIA components were modified from 12 equities to 20 components in 1916. 

Then, in 1928, they were increased to 30 stocks, which is still the standard. Eight stocks were withdrawn in 1932 and replaced with new ones, including Coca-Cola and Procter & Gamble.

The Dow Jones Industrial Average component stocks saw substantial changes because certain firms collapsed or merged during the Great Depression of the 1930s and the Great Recession of 2007/2008.

The original 12 Dow Jones Industrial Stocks were the following:

  • American Tobacco
  • American Sugar
  • American Cotton Oil
  • Chicago Gas
  • General Electric
  • Distilling and Cattle Feeding
  • Laclede Gas
  • National Lead
  • North American
  • Tennessee Coal, Iron, and Railroad
  • U.S. Rubber
  • U.S. Leather

The methodology for calculating the DJIA has also been modified. The price of the 12 stocks was divided by 12 when it was initially calculated, giving rise to a straightforward arithmetic mean. 

The Dow Divisor, modified at certain structural change events, is used to split it today.

Limitations of Dow Jones Industrial Average

There are certain limitations associated with the Dow Jones Industrial Average.

As it only includes 30 large-cap U.S. corporations, the Dow Jones Industrial Average is sometimes criticized for failing to reflect the American economy's status adequately. They contend that there are not enough businesses, and businesses of various sizes are ignored.

The S&P 500, which contains 500 firms as opposed to 30 in the Dow Jones Industrial Average, is widely regarded as a more accurate indicator of the economy. 

Additionally, some contend that using a stock's price alone in the computation does not adequately represent a corporation compared to using its market capitalization

This would lead to a misrepresentation of a firm's real size since a company with a higher stock price but a lower market cap would be given more weight than a company with a higher stock price but a bigger market cap.

The Dow Divisor and Index Calculation

The Dow Divisor was developed to solve the simple average problem. The effect of a one-point change in any of the roughly 30 stocks that make up the Dow is calculated using the divisor, a predefined constant. 

There have been instances when it was necessary to alter the divisor to maintain the Dow's value. On June 6, 2022, the Dow Divisor was 0.15172752595384.

The market capitalization of the firms that make up the Dow is not considered in its calculation, which does not use a weighted average (unlike the S&P 500). Instead, it represents the total share prices for each of the constituents divided by the divisor. 

Therefore, changing one point in any component stock will cause an equal change in the index.

DJIA price = SUM of all stocks in the Dow / Dow Divisor

1. The DJIA as a Dollar Value

Divide the stock's price change by the current divisor to see how a change in a specific stock would impact the index. As an illustration, multiplying $5 by the current divisor (0.152) yields 32.89 in the case of Walmart (WMT), which is up $5. 

As a result, if the DJIA rose 100 points on the day, Walmart was to blame for 32.89 of those points.

2. Weighing the Index

The price-weighted approach is the formula the DJIA uses to calculate an index. Then, based on the value of their shares, companies are ranked. 

The disadvantage of this strategy is that it fails to consider that a $1 change for a $10 stock is far more important (percentage-wise) than a $1 change for a $100 stock, in addition to needing to cope with stock splits.

Most other significant indices, including the S&P 500, are weighted based on market capitalization, which means that firms are ranked by the number of outstanding shares they have multiplied by the value per share. This is done because of the issues with price weighting.

Dow Index Components

To replace firms that no longer satisfy the listing requirements with those that do, the Dow is often reevaluated. The index expanded to 30 components by 1928. Since then, it has undergone several compositional changes. Some of these changes are:

  • Three months after the 30-component index's debut, the first change occurred. Several adjustments were made to its constituent parts during its early years, generally up until the Great Depression. 
  • Eight stocks in the Dow were replaced in 1932, marking the first significant shift.
  • 1997 marked the last significant change to the Dow's makeup on a broad scale. 
  • At this time, Travelers' Group took the place of Westinghouse Electric; Johnson & Johnson took the place of Bethlehem Steel; Hewlett-Packard took the place of Texaco, and Wal-Mart took the place of Woolworths.
  • Four additional Dow components were altered two years later, in 1999, when Home Depot, Intel, Microsoft, and SBC Communications were added, and Chevron, Sears Roebuck, Union Carbide, and Goodyear Tire were eliminated.
  • Walgreens Boots Alliance, Inc replaced General Electric Company on June 26, 2018. 
  • Additionally, DowDuPont separated from DuPont and was replaced by Dow Chemical Company in 2020 and 2019, respectively. United Technologies amalgamated with Raytheon Company, and the new company joined the index as Raytheon Technologies.
  • ExxonMobil, Pfizer, and Raytheon Technologies were replaced on August 24, 2020, by Salesforce, Amgen, and Honeywell.

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Researched and authored by Tanay Gehi | Linkedin

Reviewed and Edited by Aditya Salunke I LinkedIn

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