Defining Dow Jones Industrial Average (DJIA)
The Dow Jones Industrial Average (DJIA), also called simply the Dow, is a stock market index that measures the worth of 30 significant, publicly listed firms headquartered in the United States and how they moved on a typical trading day.
DJIA is the most well-known and widely-accepted barometer for US stock market performance. Often called simply the Dow, it is watched closely by investors, businesses, and the media as an indicator of the US economy's health.
History
The DJIA is the world's oldest stock market index. Charles Dow, a Wall Street Journal editor, and Edward Jones, a statistical analyst, formed it in 1896. The two men wanted to create an index that would track the overall performance of the US stock market.
The original DJIA included 12 companies. Its early constituents comprised industrial enterprises linked with gas, sugar, tobacco, railways, and oil.
The index's components have changed numerous times as companies have merged, been acquired, or gone out of business. Today, the DJIA consists of 30 large US companies.
The DJIA's calculation method has also been modified. It started as basic arithmetic mean, with the prices of the 12 stocks divided by 12. It is now split by the Dow Divisor, modified during structural change events.
How the DJIA Works
The DJIA was designed to track the movements of the largest industrial businesses in the United States. It employs a price-weighted index, which means that stocks with higher share prices have a more significant weight in the index than firms with lower share prices.
The Dow first determined the averages by summing the stock values of the 12 firms and dividing them by 12. Later, the index's formula was modified to reflect the relative importance of each component based on the proportion of the index's overall value.
The DJIA is now a price-weighted index, with the prices of the index's 30 businesses added together and then divided by the Dow Divisor. The Divisor was created to lessen the impact of structural changes such as stock splits.
Components of the DJIA
No prerequisites exist for a company to be listed on the DJIA's 30 corporate stocks. To be included in the DJIA, a firm must account for a significant portion of US economic activity.
The firm must also be listed on the NASDAQ or NYSE and be one of the leading industrial corporations. To reflect economic changes, the DJIA makes periodic modifications to its components. Among the most recent improvements are:
- Apple took over AT&T in March 2015.
- DowDuPont took over DuPont in September 2017.
- Walgreens Boots Alliance replaced General Electric in July 2018.
DJIA comprises 30 large US companies spanning various industries. These companies are:
Benefits of the DJIA
The Dow Jones Industrial Average has several benefits that make it a vital stock market index.
Firstly, the DJIA is the oldest stock market index, giving it a long history and track record. This makes it a reliable indicator of US stock market performance.
Secondly, the DJIA is a price-weighted index, which means that stocks with higher share prices have a more significant weight than firms with lower share prices. This makes the DJIA more representative of US economic activity, as big businesses are often the most critical drivers of the economy.
Thirdly, the DJIA is a widely-accepted stock market index, watched closely by investors, analysts, and the media. This means that it can be used as a benchmark for investment performance.
Fourth, the Dow is also a widely used tool for portfolio diversification. By investing in an index fund that tracks the Dow, investors can get exposure to many stocks with a single investment.
Limitations of the DJIA
The Dow Jones Industrial Average has a few limitations as an investment tool.
First, because the Dow is a price-weighted index, stocks with higher prices significantly impact the Dow's performance. This means that the Dow is often influenced more by large than small companies.
Second, the Dow only includes 30 stocks, limiting its ability to represent the US stock market. For a more comprehensive view of the US stock market, investors can look at other indexes, such as the S&P 500 or the Nasdaq Composite.
Third, some say that merely a stock's price in the computation needs to correctly reflect a corporation as much as considering a company's market value.
A firm with a higher stock price but a smaller market cap would be given more weight than a company with a lower stock price but a bigger market cap.
The Bottom Line
The Dow Jones Industrial Average is a stock market index that includes 30 large US companies spanning various industries. The DJIA has several benefits, including its long history and track record, price-weighting, and wide acceptance.
However, the Dow also has some limitations, such as its exclusion of small companies and its weighting method.
Despite its limitations, the Dow remains one of the world's most widely-followed stock market indexes.
FAQs
1. What is the Dow Jones Industrial Average?
DJIA is a stock market index that includes 30 large US companies spanning various industries.
2. How does the Dow Jones Industrial Average work?
DJIA is a price-weighted index, which means that stocks with higher share prices have a bigger weight than firms with lower share prices.
3. What are the benefits of the Dow Jones Industrial Average?
The Dow Jones Industrial Average has several benefits, including its long history and track record, price-weighting, and wide acceptance.
4. What are the limitations of the Dow Jones Industrial Average?
The Dow Jones Industrial Average has some limitations, such as its exclusion of small companies and its weighting method.
5. Is the Dow Jones Industrial Average a good investment tool?
Despite its limitations, the Dow remains one of the world's most widely-followed stock market indexes, which means it can be used as a benchmark for investment performance.
