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Understanding the Dow Jones Industrial Average (DJIA)

What is the Dow?

what to know about the dow jones industrial average: Was founded in 1896, using the stocks of just 12 companies, which were almost entirely commodity firms. There are currently 30 companies in the DJIA, including Apple, Microsoft, Walt Disney, and Chase. Its divisor is often changed for corporate events and stock actions. It has been criticized for ignoring a firm’s market capitalization Many managers opt for the S&P 500 to adjust for a firm’s market capitalization. It doesn’t provide the broadest measure of economic health.

The Balance / Hilary Allison

The Dow Jones Industrial Average (DJIA) is perhaps the most widely followed stock market index in the world. Yet, very few people know that the number represents just 30 firms.

The Birth of the DJIA

The Dow Jones Industrial Average got its start on May 26, 1896. The Dow was created by a man named Charles H. Dow, one of the founders of Dow Jones & Company (formed in 1882).

Dow's first index was created in 1884. It had 11 transportation-related stocks. He changed the original index (on Wall Street, this process is known as “reconstituting”) and renamed it the Dow Jones Rail Average. In the 1970s, the name was updated to the Dow Jones Transportation Average to cover air freight and other forms of transport.

Dow soon found that industrial firms were rising more quickly in value than railroads. He then made a new index using the stocks of 12 companies. He called it the Dow Jones Industrial Average (DJIA for short). The average was first made up of industrial companies, such as those in the cotton, sugar, tobacco, and gas sectors.

To calculate the index figure, Dow added up all of the stock prices. He then divided it by the number of companies in the index at the time.

The very first DJIA was 40.94. This meant that the average stock price of the twelve stocks Mr. Dow had chosen was $40.94.

The Original 12 Dow Jones Stocks

The original 12 stocks in the DJIA were almost entirely commodity firms and were as follows:

  • American Cotton Oil Company
  • American Sugar Company
  • American Tobacco Company
  • Chicago Gas Company
  • Distilling & Cattle Feeding Company
  • General Electric
  • Laclede Gas Company
  • National Lead Company
  • North American Utility Company
  • Tennessee Coal & Iron
  • U.S. Leather Company (Preferred)
  • U.S. Rubber Company

At the time, these were large, profitable, and highly valued firms. Most were replaced in the DJIA as their stock prices fell or they went out of business.

Changes Over Time

In 1916, the DJIA was updated to include 20 stocks. By 1928, it grew to 30. This is still the rule today.

A committee made up of S&P Dow Jones Indices representatives and Wall Street Journal editors decides which companies are included in the DJIA.

There are no rules for Dow inclusion. There is only a broad guide that requires large, respected, and substantial firms with high stock prices. In general, these firms represent a large portion of the economic activity in the United States.

Which Companies Are in the Dow Today?

The most recent update to the index took effect on August 31, 2020. Amgen, Honeywell, and Salesforce were added, while ExxonMobil, Pfizer, and Raytheon were cut. The 30 Dow companies are now:

  • Apple Inc.
  • Boeing Co.
  • Microsoft Corp.
  • Amgen Inc.
  • Walt Disney Co.
  • Travelers Cos. Inc.
  • Salesforce.com Inc.
  • Intel Corp.
  • Procter & Gamble Co.
  • Coca-Cola Co.
  • McDonald's Corp.
  • Visa Inc. Cl A
  • Cisco Systems Inc.
  • Johnson & Johnson
  • American Express Co.
  • International Business Machines Corp.
  • Walgreens Boots Alliance Inc.
  • Home Depot Inc.
  • Goldman Sachs Group Inc.
  • Merck & Co. Inc.
  • Honeywell International Inc.
  • Walmart Inc.
  • Chevron Corp.
  • 3M Co.
  • Nike Inc. Cl B
  • JPMorgan Chase & Co.
  • UnitedHealth Group Inc.
  • Verizon Communications Inc.
  • Dow Inc.
  • Caterpillar Inc.

Criticisms of the DJIA

The practical effect of Dow's calculation was that a stock with a $100 share price would have five times the influence on the DJIA as one with a $20 share price, even if the firm had a market capitalization that was 10 times as large.

That’s why a company such as Berkshire Hathaway (BRK/A), which has traded for over $200,000 per share since mid-2016, couldn’t be added to the Dow without some modification in the formula; it would inflate the entire index.

This flaw quickly became known when companies announced stock splits and other transactions that modified their nominal share prices. To make their shares more affordable, a growing company may double its number of outstanding shares by splitting them 2 to 1.

Some critics argue against ignoring the market capitalization of a firm. They state that an index tied to stocks' prices is not as accurate as one tied to their market value.

An $80 stock would fall to $40, but there would be twice as many shares outstanding. Under the original calculation for the Dow Jones Industrial Average, this cosmetic change would result in the DJIA falling even if the stock were to increase in value.

To compensate, the divisor of the DJIA is often changed for corporate events and stock actions, such as special dividends and stock splits. As a result, many money managers use the S&P 500 or other indexes that adjust for a firm's market capitalization.

The Bottom Line

The Dow Jones Industrial Average has changed quite a bit over the past 100 years and will keep changing as the economy shifts. While it isn't the broadest measure of economic health, the Dow's history and makeup can help you decipher a common financial term.

Frequently Asked Questions (FAQs)

How do you invest in the Dow Jones Industrial Average?

Many mutual funds replicate exposure to the Dow Jones Industrial Average. Buying shares in those mutual funds is like buying pieces of the Dow. There is also an ETF that trades under the ticker DIA that replicates Dow exposure. While DIA offers straight-ahead exposure to the index, proceed with caution for any other ETFs that offer Dow exposure; they may be leveraged or inverse ETFs.

What are Dow Jones Sustainability Indices?

There are a few variations on the Dow Jones Industrial Index that have environmental, governance, and societal (ESG) investing goals. These are known collectively as Dow Jones Sustainability Indices (DJSI), but they vary significantly. Some are general ESG indices for a specific region, such as the U.S. or Korea. Others have specific exclusions for specific regions, such as a European index that excludes companies that deal in firearms, tobacco, alcohol, gambling, or adult entertainment.