What is the Dow?

The Dow Jones Industrial Average tracks the 30 largest companies trading on the New York Stock Exchange.

The Dow Jones Industrial Average began life in 1896 as a simplified way for the average American to understand the health of the U.S. economy. The Dow is calculated using the 30 largest companies that trade on the New York Stock Exchange.

These companies:

• Must be members of the S&P 500 index.
• Must be domiciled in the U.S.
• Cannot be classified in the transportation or utilities sectors.
• The Dow 30 committee prefers that the price of new stocks not be more than ten times higher than the lowest-priced stock in the index.
• The Dow 30 committee prefers that new entrants pay a dividend.

Though it may be one of the most frequently referenced indexes, the Dow is also a questionable proxy for the health of the total U.S. stock market. Its total concentration on Blue Chips (very large, stable, mostly dividend-paying companies) makes it too conservative to be a true representation of the broad market.

Additionally, the make up of the index can change. For example, on June 19, 2018, investors learned of the historic news that General Electric (GE) stock has lost its position among the 30 corporate heavyweights that make up the Dow Jones Industrial Average stock market index. GE stock was a proud member of the Dow for 111 uninterrupted years.

A variety of factors contributed to this stunning change of events, including the Dow’s lower emphasis on manufacturing companies, GE’s struggling finances, and its very low share price. The Dow is a price-weighted index, meaning that a low-priced stock like GE cannot contribute meaningfully to the index’s value.

By replacing GE with a much higher-priced stock, the value of the index can rise more than it would by continuing to hold any low-priced stock, whether that stock belongs to GE or a rapidly growing company. With regard to the index’s price-weighting, a writer for the Financial Times stated, “I have long contended that [the DJIA] is a pointless and mathematically unsound index that measures nothing in particular.”

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