What is the Dow Jones Industrial Average (DJIA)?
Editorial staff, J.P. Morgan Wealth Management
- The Dow Jones Industrial Average (DJIA) is a price-weighted market index comprising stocks of 30 blue-chip companies that trade on the New York Stock Exchange (NYSE) and Nasdaq.
- The index was created by Charles Dow and Edward Jones in 1896 to serve as a snapshot of the broader U.S. economy.
- The stocks in the DJIA are not necessarily the 30 largest companies but are chosen because of their relevance to the current U.S. economy.
- You can’t directly invest in the index, but you can invest in companies that make up the DJIA or an index fund that tracks its composition and performance.
You might have heard news reports that mentioned the Dow Jones Industrial Average (DJIA) when talking about the performance of the stock market. But what exactly is the DJIA and why does it matter? We break it down for you.
The DJIA is a market index that is made up of the stocks of 30 blue-chip companies that trade on the New York Stock Exchange (NYSE) and the Nasdaq. Commonly known as the Dow 30, this index is named after its creators, Charles Dow and Edward Jones.
When was the DJIA created?
The DJIA launched in 1896 and consisted of 12 companies that were primarily in the industrial sector. At that time, the performance of industrial companies, especially those that focused on industries such as railroads, cotton, gas, sugar, tobacco and oil, was closely linked to the performance of the overall U.S. economy.
Today, to keep up with the changes that the U.S. economy has undergone over the past 126 years, the DJIA is composed of 30 stocks that represent every part of the economy except the utility and transportation sectors. The stocks from these sectors are represented by the Dow Jones Utility Average and the Dow Jones Transportation Average, respectively.
The expansion from 12 to 30 companies happened in two stages. The first stage was in 1916 when the index grew to 20 stocks, and the second stage happened in 1928 when the number of stocks increased to 30, its current number.
Does market capitalization influence the DJIA?
Simply put, it doesn’t. The DJIA is a price-weighted index, so it doesn’t pay that much attention to a company’s market capitalization (unlike other indexes, like the S&P 500, which is a market cap-weighted index).
The term “market capitalization” refers to the current market value of a publicly traded company’s stock. It is calculated by multiplying the company’s outstanding shares by the current market price. For example, if a company has 100 million outstanding shares and the current market price of each share is $15, then its market cap is $1.5 billion. A point of note – this is not its intrinsic value, which is its actual worth, but rather what the stock market estimates as its value.
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So what does it mean to be a price-weighted index?
Because the DJIA is a price-weighted index, stocks with a higher price per share will have a greater weight in the index. In other words, a percentage move in the higher-priced stocks will have a proportionally larger impact on the index than a similar percentage move in lower-priced stocks.
How are companies selected to be included in the DJIA?
The universe for inclusion in the DJIA are securities in the S&P 500 index, excluding stocks in the transportation or utilities sectors. Unlike the S&P 500, which consists of the 500 largest companies, the companies in the DJIA are not necessarily the 30 largest companies. Rather, they are chosen because of their significance in their respective sectors.
The key point is that there isn’t a quantitative rules-based methodology for selecting the stocks that make up the DJIA. Usually, changes are made in response to corporate or market developments. Essentially, the companies selected must be relevant to the current U.S. economy.
The components are chosen by the “Averages Committee,” which is made up of three representatives of S&P Dow Jones Indices and two representatives of The Wall Street Journal.
That said, there are a few guideposts that the committee follows in the selection process. These include:
- The company must be listed on the NYSE or Nasdaq.
- The company must be “incorporated and headquartered in the U.S., and a plurality of revenues should be derived from the U.S.”
- The company should have “an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors.”
- The highest-priced stock should be more than 10 times greater than the lowest-priced one.
- The committee tries to ensure that there is adequate sector representation.
What is the DJIA sector allocation?
The market sectors represented in the DJIA are based on the Global Industry Classification Standard (GICS), which was developed by MSCI and S&P Dow Jones Indices in 1999. The sector allocation of the 30 stocks is as follows:
The DJIA sector allocation
Is there any criticism of the DJIA?
As with anything in life, the DJIA does have its critics. Some believe the DJIA is not a good a barometer of the U.S. stock market’s health because it includes so few companies. These critics often prefer the S&P 500, which includes the 500 largest companies on the market.
Also, some dislike the price-weighted methodology used in the DJIA, arguing that one company in the index can exert a disproportionate influence simply because its stock trades at a higher price than a company that is actually much larger in terms of market cap.
Finally, critics point to the subjective selection process used to include companies in the index.
Nevertheless, when you read a headline about how the stock market is performing, you will probably see the DJIA’s number given as proof.
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Editorial staff, J.P. Morgan Wealth Management
