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How the Dow Jones Industrial Average works |
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Written by Marshal Brain, HowStufWorks.com, MCT
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Tuesday, 29 May 2007 |
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It has been hard to miss the news about the stock market for the last couple of weeks. The Dow Jones Industrial Average has been setting new record highs. Which begs the question: what is the Dow Jones Industrial Average?
Historically, the Dow Jones Industrial Average started back in the late 1800s. The creator of the index was Charles Dow, who at the time was editor of the Wall Street Journal and was also one of the founders of Dow Jones & Company. Dow Jones & Company is a large American publishing company that publishes, among other things, the Wall Street Journal.
Charles Dow was looking for a shorthand way of seeing the health of America's industrial stocks, so he took 12 of the biggest industrial stocks at the time, looked up their stock prices each day, and averaged them together. In other words, he took the prices of all 12 stocks, added them up and divided by 12. There was no magic to it. In May of 1896 when he first computed the average, it came out to $40.94. That is, the average price of the 12 biggest industrial stocks in 1896 was about $40. Just a few months later, the average had fallen to $28.48 — it fell about 40 percent. That was the lowest that the Dow Jones Industrial Average has ever been.
Looking at those 12 original companies is interesting. One was the American Cotton Oil Company. It eventually turned into Bestfoods, which has become a little piece of Unilever, which makes everything from Lipton Tea to Vaseline. Another was the U.S. Leather Company, which went out of business in the 1950s. Another was the National Lead company, which still exists today as NL Industries.
Because companies are always splitting and combining and going out of business, the companies in the Dow Jones Industrial Average change over time. Today there are 30 companies rather than 12, and it is not a straight average anymore. Instead of dividing strictly by 30, the divisor changes as stocks split and as stocks move in and out of the index.
Today the 30 companies are much more diverse than they used to be. They are no longer all "industrial" stocks. But they are some of the largest and best known companies in America. Household names like Coca-cola, McDonald's and Wal-Mart are in the list. Pharmaceutical companies like J&J, Merck and Pfizer are in the list. There are tech companies like IBM, Intel, Microsoft and HP. And there are some big industrial companies like Caterpillar, GM, GE and Boeing. As such, the list represents a fairly broad slice through the most important sectors of the American economy.
Is the Dow Jones Industrial Average perfect? No — nothing is perfect. So there are a whole bunch of other popular indexes that people also use to gauge the market. There is the "S&P 500", which takes 500 of the largest stocks in America and creates an index out of them. There is the "NASDAQ 100" — an index created out the largest 100 stocks traded on the NASDAQ stock exchange. And so on — there are hundreds of indexes like these that people use. Many investors look at several indexes to gauge the health of the market.
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Looking for more? For more on this or the scoop on other fascinating topics, go to HowStuffWorks.com. Contact Marshall Brain, founder of HowStuffWorks, at
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