Dow Jones Index Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Dow Jones Index, also known as the Dow Jones Industrial Average (DJIA), or often simply the Dow 30 Industrials, is a price-weighted average of 30 U.S. blue-chip stocks. These are shares of some of the largest and most financially strong and stable companies in the United States. As the second-oldest continuing U.S. stock market index, it remains one of the most widely reported indicators of the price performance of U.S. equities.

The index was originated by Charles Dow (1851–1902), one of the founders of Dow Jones and Company, who began publishing the daily average prices of 12 “industrial” stocks in The Wall Street Journal in 1896. In 1916 the index sample was increased to 20 stocks, and then in 1928 to 30 stocks, where it has remained to the current day. In 1956 the DJIA became the first stock index to be made available in real time during trading hours.

In 1884 Dow began publishing an earlier index of 11 primarily railroad stocks that was published in Customer’s Afternoon Letter, a precursor to The Wall Street Journal. In 1896 the last non-railroad stock was removed from this index, which became a 20-stock average of railroad stocks. As a result of the change in its composition over the years, this index was renamed the Dow Jones Transportation Average (DJTA) in 1970.

The DJTA has the distinction of being the U.S. oldest continuing stock market index. Also among the most commonly referenced Dow stock indices is the Dow Jones Utility Index (DJUA), which was established in 1929 and includes 15 large natural gas and electricity utilities. Together these three indices and their combined 65 stocks comprise the Dow Jones Composite Average. Reportedly, Dow’s goal in publishing stock indices was to provide market participants measures of longer-term trends in stock prices that minimized the import of daily, random price fluctuations.

Composition

The composition of the Dow 30 is determined by the editors of The Wall Street Journal. Changes are infrequent and are usually driven by a change to one of the component companies, such as its acquisition or a significant change in its business. Whenever a change is required, all component stocks are reviewed. Historically, the DJIA index’s composition has been less “industrial” than its name suggests. Reportedly, the editors look to include large successful companies whose shares are widely held and are not represented in the separate indices for both transportation and utility companies. In general, the composition of the DJIA index has changed to reflect the changing American economy as it has developed over the past century from the dominance of agricultural and commodity production to leadership from such sectors as technology, retail, and financial. These changes are reflected in the original and recent lists of companies included in the index.

In 1896 the DJIA originally consisted of the following 12 companies: American Cotton Oil; American Sugar; American Tobacco; Chicago Gas; Distilling & Cattle Feeding; General Electric; Laclede Gas; National Lead; North American; Tennessee Coal & Iron; U.S. Leather (preferred); and U.S. Rubber. Among these companies in the original index, only General Electric remains on the current DJIA. (However, General Electric has not been in the index continuously; it was not included from 1898 to 1899 or from 1901 to 1907.)

Currently in 2008 the Dow 30 includes the following companies: 3M Company; Alcoa Incorporated; American Express Company; American International Group, Inc.; AT&T Incorporated; Bank of America Corporation; Boeing Company; Caterpillar Incorporated; Chevron Corporation; Citigroup

Incorporated; Coca-Cola Company; DuPont; ExxonMobil Corporation; General Electric Company; General Motors Corporation; Hewlett-Packard Company; The Home Depot Incorporated; Intel Corporation; International Business Machines; Johnson & Johnson; JPMorgan Chase & Company; McDonald’s Corporation; Merck & Company, Incorporated; Microsoft Corporation; Pfizer Incorporated; Procter & Gamble Company; United Technologies Corporation; Verizon Communications, Inc.; Wal-Mart Stores Incorporated; and Walt Disney Company. All but two of these 30 companies are listed on the New York Stock Exchange. The two exceptions are Microsoft and Intel, which are traded on NASDAQ. Both companies, the first technology stocks in the index, were added in 1999.

Calculation

In the original calculation of the index, the 30 stock prices were summed and that sum was divided by 30. The first DJIA reported on May 26, 1896, was 40.94. The divisor of 30 has had to be adjusted frequently over the years to reflect stock splits, in which the number of shares outstanding is increased by issuing additional shares to existing shareholders, spin-offs, rights issues, and large or special cash dividends. The divisor is also adjusted when the component stocks are changed so that the average is unaffected by the change. In June 2008 the prices of the 30 stocks in the index were added and divided by a divisor of 0.122834016. The resulting number is expressed in terms of “points.”

As a result of its methodology, the index gives greater weight to higher-priced stocks. For any given percentage change to a stock’s price, the price change to the higher-price stock will result in a larger change to the DJIA than will the same percentage change to a lower-priced stock in the index. To determine the impact of any one stock’s price change on the index, the price change is divided by the Dow divisor. For example, a $5 increase in any one stock’s price would increase the DJIA by 40.7 points (5/0.122834016 = 40.70534). In the years before the financial crisis of 2008, the index had risen higher than 14,000 points. In the previous decade the index rose from 2,588 in January 1991 to 11,302 in January 2000, topping 10,000 in 1999, 10 times its 1972 level.

Criticisms And Theories

Although the Dow 30 is criticized as being too small a sample to be representative of the movement of the larger market, it continues to be the most closely watched and reported U.S. stock market index, even exceeding the coverage given to the S&P 500 Index and the even larger NASDAQ Composite, which includes over 3000 stocks. As an indicator of the price movement of large cap stocks, the Dow 30 has been found to be highly correlated with the much broader S&P 500. Other criticisms of the Dow include the imprecision of the selection criteria for inclusion in the index and the regular necessity of the recalculation of the divisor. Regardless, with its long history and regular publication and promotion in The Wall Street Journal, the Dow has stood the test of time across generations of market participants as the principal barometer of the broad price performance of U.S. equities for over 100 years.

As a broad index of common stock price trends, the Dow Index has been the basis for a number of stock market trading strategies. The most famous is the Dow Theory, a form of technical analysis developed by Charles Dow’s successor as editor of The Wall Street Journal, William Peter Hamilton. Formally named in Charles Rhea’s 1932 Dow Theory, this market timing strategy seeks to offer buy or sell signals based on primary trends in the market as represented by the Dow Jones Industrial and Transportation Averages. This market timing strategy attempts to differentiate primary trends, socalled bull or bear markets that are believed to alternate regularly, from both secondary market corrections that may persist for a few months and tertiary daily random price fluctuations that can be ignored.

Another trading strategy based on the Dow Index is the so-called Dow 10 or Dogs of the Dow that involves investing equal amounts in the 10 stocks in the Dow 30 that have the highest dividend yields (the ratio of the annual dividends paid on a stock to the current market price of the stock) in any given year and then repeating the process each year as the composition of the Dow 10 changes. Debate continues on the ability of such trading strategies based on movements in the Dow Index to generate consistently high returns.

Bibliography:

Bernard and G. Galati, “Special Feature: The Co-Movement of US Stock Markets and the Dollar,” BIS Quarterly Review (August, 2000);
Dow Jones and Company, www.djindexes.com (cited March 2009);
Francis and R. Ibbotson, Investments: A Global Perspective (Prentice Hall, 2002);
Fraser, Every Man a Speculator: A History of Wall Street in American Life (HarperCollins, 2005);
Gupta, “The Past and Present and Prologue to the Future of the Dow” (Dow Jones and Company, 2006);
Higgins and J. Downes, Beating the Dow (Harper Perennial, 1992);
Kirby, “Demise of the Dow,” Macleans (October 23, 2006);
Reilly and K. Brown, Investment Analysis and Portfolio Management (Thomson South-Western, 2005);
Rhea, The Dow Theory (Barron’s, 1932);
Salomon, Jr., “The Outdated Dow Jones,” Forbes (April 7, 1997);
Shalen, “Another Look at Dow Theories” (Chicago Board of Trade, 2008).

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