What is the Dow Jones Industrial Average (DJIA)?
The Dow Jones Industrial Average (DJIA) is a stock market index that tracks 30 large and publicly traded U.S. companies.
The DJIA, sometimes simply referred to as “the Dow”, is one of the oldest and most-watched benchmarks for the U.S. stock market.
Overview of the Dow
The Dow Jones Industrial Average was created in 1896 by Charles Dow, co-founder of the Dow Jones & Company and founding editor of The Wall Street Journal.
Originally consisting of just 12 industrial stocks, the index has evolved over time to reflect the changes that the U.S. economy has experienced.
7 Key Features of the DJIA
- It tracks 30 major U.S. companies trading on the New York Stock Exchange and NASDAQ. The components span across various industries excluding utilities and transportation.
- The index serves as a proxy for the broader health and direction of the U.S. stock market and economy.
- It is a price-weighted index, meaning stocks with higher per-share prices are given greater weight in the index.
- The composition of the DJIA changes over time as companies become less relevant or impactful. Stocks are added and removed from the index based on the decisions made by a selection committee.
- On average, the Dow components are changed only every two to three years. Changes are rare.
- The price of the index is calculated by adding the per-share prices of the 30 stocks and dividing the sum by the Dow Divisor. The divisor allows the index to adjust for corporate actions like stock splits.
- The DJIA is owned, managed, and published by the S&P Dow Jones Indices company, a joint venture between S&P Global and the CME Group.
The DJIA Stocks/Components
The DJIA has evolved greatly since its inception back in 1896, when it tracked only 12 industrial stocks. It expanded to 20 stocks in 1916 and grew to its current 30 components in 1928.
These are the 30 companies currently in the DJIA as of October 2023:
Johnson & Johnson
Procter & Gamble
JP Morgan Chase
Calculating the DJIA
Unlike other major stock indexes, the Dow Jones Industrial Average is not weighted by market capitalization. Rather, it is a price-weighted index, making it unique among its peers.
The DJIA value is calculated by:
- Adding up the per-share prices of all 30 component stocks.
- Dividing the resulting total by the Dow Divisor.
The Dow Divisor, which currently stands at around 0.15, is adjusted periodically to account for corporate actions like stock splits to maintain the price continuity of the index despite these modifications.
Due to its price-weighting methodology, stocks with higher per-share prices have an outsized impact on index movement. A $1 change in a $100 stock price equates to a 100-point move in the index.
Understanding the DJIA vs. Other Major Indexes
The DJIA is often compared to other major stock indexes like the S&P 500 and the NASDAQ Composite. Here are some key differences:
- The S&P 500 tracks the 500 largest U.S. stocks weighted by market cap. The NASDAQ Composite tracks nearly 3,000 stocks listed on the Nasdaq exchange. Both represent the broader market better than the narrower 30-component DJIA.
- The S&P 500 and NASDAQ are market cap-weighted indexes, while the DJIA is price-weighted.
- The DJIA underweights high-priced stocks like Apple (AAPL), which are major components of the S&P 500 and NASDAQ.
- The DJIA is more exposed to industrial and financial stocks, while the S&P 500 and NASDAQ have greater weightings toward technology firms.
Despite the differences, the DJIA tends to correlate directionally with the broader market over time. However, these other two indexes are viewed as more representative of the market’s near-term performance.
The DJIA Impact and Usage
The DJIA has been one of the most visible and trusted measures of the performance of the US stock market since its inception. It impacts investors’ perceptions in the following ways:
- Performance is widely reported by financial media as the main indicator of market sentiment. The DJIA milestones influence investor psychology.
- The index provides a benchmark for investment managers to evaluate the performance of their portfolios.
- It acts as the basis for derivatives like options and futures contracts that are used to trade the index.
- ETFs and mutual funds track or mimic the DJIA, allowing individual investors to get exposure easily via these instruments.
- Global companies aspire to be added to the prestigious Dow 30 list.
How to Invest in the Dow Jones Industrial Average?
While it is not possible to directly invest in the Dow Jones Industrial Average itself, investors can gain exposure to the index via one of these investment vehicles or methodologies:
Purchase the 30 Dow Jones Stocks
- Since the Dow Jones tracks 30 large-cap U.S. stocks, one approach is to simply buy shares of all 30 companies.
- This allows investors to own each of the components within the index.
- However, the exact weight assigned to each stock within the portfolio must be replicated as well. Otherwise, the performance may vary widely from the benchmark over time.
Invest in a Dow Jones ETF
- A more convenient way to invest in the Dow is via an exchange-traded fund (ETF) that tracks the index. The SPDR Dow Jones Industrial Average ETF (DIA) directly mirrors the 30 Dow stocks and trades like common share. The fund has an expense ratio of just 0.16%, and it is managed by State Street Global Advisors.
- Other DJIA index funds are leveraged versions of the latter, like the ProShares Ultra Dow30 (DDM), which has an expense ratio of 0.95%.
- This ETF doubles the gains or losses that the index experiences during any given trading session. ETFs are the easiest and cheapest approach to get exposure to the Dow Jones.
Trade the Dow Jones Futures and Options
- The Dow Jones index has derivatives like futures contracts and options that allow traders to speculate on its price movements.
- Dow futures and options are traded on the Chicago Board of Options Exchange (CBOE).
- However, derivatives carry risks and are complex instruments that may be best suited for experienced traders.
‘Dogs of the Dow’ Strategy
- One long-standing value investing strategy is the “Dogs of the Dow”. This approach involves buying the 10 highest dividend-yielding Dow stocks at the start of each year, under the rationale that high yields are an indicator that the stock is undervalued.
- An investor would hold the 10 Dow “dogs” for the entire year in their portfolio and will then replace the stocks with the ones that comply with this same criterion at the beginning of the new year.
Despite its limitations, the Dow Jones Industrial Average remains one of the most influential indexes reflecting the health and direction of U.S. stock markets.