What is the Dow Jones Industrial Average and can you invest in it?
The Dow Jones Industrial Average has been discussed on this site in a number of different posts. It is also a term that you hear often in the news and general investment discussions. The Dow Jones Industrial Average (DJIA) is actually quite a simple concept. It is an index that shows how 30 of the largest American companies traded as at the close of the last stock market trading session. It is the second oldest index and the “Industrial” in its name is a historical nod to the typical large companies that previously made up the index- those being large industrial entities.
Some indexes give more arithmetic weight to larger companies, meaning, the bigger or larger the company’s market capitalization (recall this is the stock price multiplied by the shares outstanding), the more weight or perhaps, “importance” it would have in the index. It could push or pull the index one way or the other because it had more arithmetic weight in the equation. The DJIA is not calculated this way, rather, the DJIA is calculated by adding up the stock prices of all the 30 stocks in the index. Before things like stock splits and dividends were common among such large companies, that was the extent of the calculation required for the DJIA. Today however, the sum of the 30 stock prices is divided by the “Dow divisor”. The Dow divisor takes into account the fact that stock splits and dividends have not changed the actual value of the company so it is constantly being updated to reflect the true value of the index. You can find the hourly DJIA and the divisor here. The fact that the DJIA is weighted based on price (ie. higher price stock has more impact on the index than a lower priced one regardless of the size of the company), also has it critics as it means the high priced stocks can have more impact on the DJIA.
The companies comprising the DJIA are typically what you would expect: 3M, American Express, Apple, Coca-Cola, IBM, McDonald’s, Nike, etc. The original 30 companies on the DJIA included: General Electric (recently removed in 2018), American Cotton Oil Company, American Sugar Company, American Tobacco Company and National Lead Company. It would seem the index is a real reflection of what is valued and relevant in society at any given time!
What does it mean then when the Dow is “up” or “down” and does it relate to the overall health of the economy? Based on what was discussed above, the Dow being “up” simply means stock prices of the 30 companies in the index (or at least the high priced ones given their impact on the overall DJIA) have moved higher and likewise when it is “down”, the opposite has occurred. Does this correspond to the economy being good or bad? I found an excellent article on this very question by John Jacobs of the McDonough School of Business’s Center for Financial Markets and Policy at Georgetown University in his article “Don’t confuse Dow Jones records from overall economic prosperity”. The articles’s premise is that stock markets are just a segment of the overall economy and companies are operating to maximize shareholder wealth. They are not immune to worldwide economic events but are primarily concerned with profitability for shareholders. This means the stock prices of 30 large American companies may not always be representative of the larger economy. Psychologically and in the media however, the Dow definitely is used as a marker of the overall economy.
Finally, how can you invest in the DJIA? You cannot invest in the DJIA itself as it simply is an index, not an investment product. However, you can invest in any of the stocks that make up the 30 companies on the DJIA or you could invest in an ETF or index fund that mimics the DJIA. For example, check out the SPDR Dow Jones Industrial Average ETF. This ETF “seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Dow Jones Industrial AverageSM.” It is currently at $239.45 a unit and has 30 holdings (Boeing, Apple, 3M, Home Depot, Visa, etc.) and has a P/E of 17 (check out posts on this site under The Basics for in depth information as to what P/E is and other relevant analysis terms). There are various funds and ETF’s like this if you are interested in investing in a stable group of companies like those that make up the DJIA.
**** Top photo by Daniel Olah @unsplash