Last week, Apple Inc. joined a venerable coterie of 30 companies that make up the Dow Jones Industrial Average (DJIA). Apple replaced AT&T, which departed the index for the third time in its storied history. Given the widespread interest in the change and the ubiquity of the index, a brief look at its creation and construction is in order.
Charles Dow was a publisher and a student of the stock market who founded the Wall Street Journal along with two partners in 1889. (Had one of the partners not retired early we might be discussing the Dow Jones Bergstresser index). Over the next decade, Dow developed a set of indicators or indexes that would concisely communicate the daily state of the market and could be widely reported to investors and interested readers. His first attempt was a tally of the prices of railroad company stocks that later became the Dow Jones Transportation index.
In 1896, Dow refined his methodology and created a compilation of 12 industrial corporations that eventually became the modern Dow Jones Industrial Average. The constituents of the index were selected to represent the broader industrial economy of the United States that was enjoying substantial growth during that late 19th century.
Of the original companies in the index, only one remains today: General Electric. Many of the charter members are long forgotten, like the Tennessee Coal and Iron Co., American Cotton Oil Co., and U.S. Cordage. The total number of stocks included increased in 1916 and again in 1928 to the present number of 30.
On its first day in 1896, the DJIA closed at a value of 68. By 1972 the index finally reached the 1,000 mark, where it languished for the next decade. The benchmark hit 2,000 in 1987, and had ascended to 6,500 when former Fed chairman Alan Greenspan wondered aloud whether the market was subject to "irrational exuberance". Last Tuesday, the Dow closed at 18,000.
The Dow Jones Industrial Average is easily the most iconic of the myriad market indicators and indices that are reported to investors each day. Today, the index is owned and maintained by Standard and Poor's, which also publishes the Dow's closest competitor, the S&P 500 index.
The DJIA is essentially an average of the stock prices of the 30 member stocks in the index (after an adjustment for splits and stock dividends). It is a price-weighted index, meaning that a one dollar change in the price of any stock has the same impact as a one dollar change in any other member stock. This is often viewed as a weakness in the Dow as a broad market indicator, since the size of each company and their relative prices is immaterial in computation of the daily value. For example, the most expensive stock in the index is Goldman Sachs at $189 per share, while the cheapest is GE at $25. This implies that a one dollar change is eight times bigger for GE in percentage terms, but has the same impact on the index in either case.
The S&P 500 index, to the contrary, is market-capitalization weighted, so that the changes in prices are proportionately adjusted to contribute equal percentage impact in the index. For this reason, the S&P 500 is generally considered to be a better broad representation of large U.S. company stocks.
Nevertheless, the DJIA retains its position as the most visible and broadly reported market index for the U.S. stock market and will likely continue to occupy a central place in the nightly business reports for some time to come. Charles Dow would be proud.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.