Dow Jones Industrial Average

Dow Jones & Company, as well as a great many other financial publishers, literally calculate thousands of stock indexes and averages every day. However, there is no question that the most significant, most watched and most reported is the Dow Jones Industrial Average. This average, computed from the prices of 30 stocks, is sometimes referred to as the Dow Jones Average, the Dow 30 or simply the Dow. Whenever media reporters state that "the market" is down or "the market" is doing well, they are almost always talking about the Dow 30.
Dow Jones & Company was founded in 1882 at 15 Wall Street, New York and started out by delivering hand-written stock market information (called the "Customers' Afternoon Letter") to investors in the Wall Street area. In 1884, the Dow Jones Average consisting of 9 railroads and 2 industrials first appeared in these newsletters. Eventually the "Customers' Afternoon Letter" evolved into the Wall Street Journal first published on July 8, 1889.

On May 26, 1896 for the first time an average consisting entirely of 12 industrial stocks is published. To see the list of these 12 companies (as well as all such lists from 1896 to the present), click here. On October 4, 1916 it was calculated on the stock prices of 20 companies and finally on October 1, 1928 it was increased to 30 companies, the same number as it is today.

There are no specific criteria by which a company is chosen to be on the Dow 30. Generally, the Dow 30 is composed of very large companies that represent a variety of industries in the economy. You will never see the Dow 30 list consisting of companies that are all in the same industry.

Any decision to add or remove any of the companies which make up the Dow 30 is made by the editors of the Wall Street Journal.
Also, there is no particular schedule by which Dow 30 companies are changed. The list of Dow 30 companies went from June 1, 1959 to August 9, 1976 completely unchanged. Then again changes have been made in less than 1 month. (The Dow 20 remained unchanged for only 3½ weeks from December 7, 1925 to December 31, 1925.)

One of the major reasons for removing or adding companies to the Dow 30 list is to reflect major changes in the economy. Some of the companies that were on the list such as Remington Typewriter, Victor Talking Machine and Pacific Mail Steamship now seem very out of place in today's economy. Two of the more recent additions, Microsoft and Intel, reflect the high technology aspect of the 21st century economy.

The Dow Jones Industrial Average is not the only Dow Jones average. There is also the Dow Jones Railroad Average, first published in October 26, 1896. This average was always calculated from the stock prices of 20 railroad companies until 1968. Over 70 years, the economy had changed so much that railroads were no longer the major mode of transportation and so the list now consisted of 20 transportation companies. In 1970, the name was changed to the Dow Jones Transportation Average, by which it is still known today.
On January 2, 1929, the Dow Jones Utilities Average, calculated from 18 utilities, appeared for the first time. Six months later it was calculated from twenty utilities. In June 1938, it was based on 15 utilities and this number has remained to this day.

How the Average Is Calculated
In 1896, the Dow Jones Industrial Average was easily calculated by adding the price of each company's stock and then dividing by 12. This simple procedure became more complicated whenever a company underwent a stock split.

A company decides to make a stock split whenever its stock price becomes a little too expensive. For example, a company whose stock price has increased to $1,000 may feel that investors would be reluctant to buy such expensive shares. The company might decide to make a 4 for 1 stock split which means that every share everyone owns now becomes 4 shares but each is now worth $250. So, shareholders have not become 4 times richer, the company's worth has not quadrupled and the only change is that the stock price is at a more attractive $250.
These stock splits had to be taken into account ever since 1896 and by 1927 the average was computed by mutiplying American Can's stock price by 6, General Electric by 4, Sears by 4, American Car and Foundry by 2 and American Tobacco Tobacco by 2 and then dividing by the number of stocks on the index. As can be seen, this calculation was getting increasingly complicated and so on October 1, 1928 the Dow divisor made its first appearance. Its value at that time was 16.67 and so the stock prices of the Dow 30 would be added up and then divided by 16.67.

Let's use an example to show the way in which the divisor works.
To make things simple, we'll only use 3 fictitious companies (with their closing prices):
Arizona Aircraft    1,200
Boston Bismuth    227
Carolina Cable    73
So for these 3 companies, the fictitious Dow 3 Average would simply be the total divided by 3

Average = 1,500 ÷ 3 = 500
Now at the close of the business day, Arizona Aircraft decides to make a 4 for 1 stock split and so its stock price is now $300. If we add up the stock prices we get 600 and dividing by 3 we only get 200. However, the Dow average must be consistent and can only change values based upon actual changes in stock price and not stock splits. In other words, the Dow 30 can't close with one value and then open on the next day with a drastically different value.

So, to calculate a new divisor, we use the formula:

So, the new divisor = 3 * (600 ÷ 1500) = 3 * .4 = 1.2
Calculating the "new" average we get a total of 600 and dividing it by 1.2 equals 500 which is exactly the same as the "old" average, thus leaving the Dow 30 average unchanged. One of the strange results about using the Dow divisor is that now the "average" stock price of the 3 companies is larger than any one of those three stocks (but we know that the "real" price of Arizona Aircraft is $1,200, right?)

From this point on, we would continue to use the new divisor of 1.2 until another stock split occurred or if any companies are added to or removed from the Dow 30 list. So, for example, several months after that stock split calculation, our fictitious Dow 3 closes at the following prices:
Arizona Aircraft    316
Boston Bismuth    215
Carolina Cable    75
and the 'Dow 3' average is 505 (you did remember to divide by 1.2 and not 3 right?)
Now let's suppose the editors at the Wall Street Journal decide that Delaware Drilling (which closed at $13 per share) will replace Boston Bismuth.
So, the opening prices of the 'Dow 3' will be:
Arizona Aircraft    316
Delaware Drilling    13
Carolina Cable    75
We now need a different divisor value. The new sum is 316 + 13 + 75 = 404 and the old sum is 316 + 215 + 75 = 606.
New divisor = 1.2 * (404 ÷ 606) = .8
Is this correct? The new sum of our fictitious Dow 3 is 404 and dividing that by .8 equals 505 which exactly equals the previous night's closing figure.

Calculating The New Dow Divisor for February 19, 2008
Effective 02-19-2008, 2 companies were removed and 2 were added to the list of companies that comprise the Dow 30 list. Because of this, a new divisor must be calculated.
On 02-15-2007, the closing prices for the stocks that make up the Dow 30 were:

  Company Name       Company Name       Company Name    
  3M Co.   79.95   Alcoa Inc.   35.72   Altria Group Inc.   72.53
  American Express Co.   45.11   American International  46.11   AT&T Inc.   37.88
  Boeing Co.   85.18   Caterpillar Inc.   69.95   Citigroup Inc.   25.48
  Coca-Cola Co.   58.76   DuPont de Nemours & Co.   45.49   Exxon Mobil Corp.   85.37
  General Electric Co.   34.37   General Motors Corp.   26.13   Hewlett-Packard Co.   43.87
  Home Depot Inc.   27.52   Honeywell International  56.04   Intel Corp.   20.11
  International Business Machines   106.16   Johnson & Johnson   62.90   JPMorgan Chase  43.25
  McDonald's Corp.   55.30   Merck & Co. Inc.   47.53   Microsoft Corp.   28.42
  Pfizer Inc.   22.33   Procter & Gamble Co.   66.30   United Technologies  71.53
  Verizon Communications Inc.   37.83   Wal-Mart Stores Inc.   49.44   Walt Disney Co.   32.49

Adding up these 30 amounts, we get 1,519.05 which shall now be considered as the "old sum" for our divisor formula.
A "new sum" will have to be calculated because 2 companies have been added to the Dow 30 and 2 others have been removed.
Closing prices for these companies were:
Altria 72.53
Honeywell 56.04
Bank of America 42.70
Chevron 83.46
Adjusting the "old sum" by subtracting the first 2 numbers and adding the remaining numbers, we get 1,516.64 and from the formula, we see that:

New Divisor = Previous Divisor * (New Sum ÷ Old Sum)
New Divisor = .123017848 * (1,516.64 ÷ 1,519.05)
New Divisor = .122834016
And if we go to the official Dow Jones website, we see this is precisely the value that they have posted.


Actual Calculation of the Dow 30 Average for 03-07-2008
On 03-07-2008, the closing prices for the stocks that make up the Dow 30 were:

  Company Name       Company Name        Company Name     
  3M Co.   76.51   Alcoa Inc.   36.60   American Express  41.53
  American International  42.88   AT&T  35.01   Bank of America  36.74
  Boeing  76.60   Caterpillar  69.84   Chevron  85.26
  Citigroup  20.91   Coca-Cola  58.85   DuPont  45.00
  Exxon Mobil  82.49   General Electric  32.23   General Motors  21.96
  Hewlett-Packard  47.31   Home Depot  25.88   Intel  20.07
  IBM  113.94   Johnson & Johnson   61.51   JPMorgan & Chase  37.56
  McDonald's  52.27   Merck  41.75   Microsoft  27.87
  Pfizer  21.35   Procter & Gamble  65.80   United Technologies  67.49
  Verizon  35.08   Wal-Mart  49.90   Walt Disney  30.76

If we add up all 30 amounts, we get 1,460.95. Now we must divide this total by the Dow Jones Industrial Divisor, whose value on March 7, 2008 was 0.122834016 and so 1,460.95 ÷ 0.122834016 equals 11,893.69 which was the precise closing value of the Dow Jones Industrial Average for 03-07-2008.



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