How Is the Dow Jones Industrial Average Calculated?
By Bonnie McLellan, Portfolio Manager
In 1987, a year after I started working in a trust department as an assistant portfolio manager, the DJIA (Dow Jones Industrial Average) was trading around 2,000. That year on October 19th, Black Monday, the market lost 508 points in one day, down a historic 22.6%. You could not sell or buy stocks because the market was overwhelmed, and trading was accelerated by the use of computerized trading. I remember listening to the radio, not believing what was happening. Real- time information was not as accessible as it is today and typically required a phone call to a broker to obtain. Since then, the New York Stock Exchange has installed ‘circuit breakers’, designed to stop trading when stocks decline too quickly. Today, if stocks lose 7%, the trading on the market is suspended for 15 minutes. A market decline of 20% would shut down trading for the remainder of the day.
This is not the premise of this story, but an example of what has happened to the DJIA in the past. Since then there have been many volatile days and weeks. Monday, March 2, 2020 was the largest one-day increase of 1,293.96 points, or 5.09%, for the index. That preceded Monday, March 9th when the index saw its worst one- day decline of 2,013.76, or 7.79%. But here we are still trading at a level more than 1,300% higher than we were at the end of that dark day in October, 1987.
To avoid all the whiplash and associated headaches, Trust Company of Vermont has developed a set of principles that tells us what to do over the long-term in the face of day-to-day changes in asset prices and business fundamentals. This is at the core of value investing. Our challenge is to weed out the noise, control our emotions, use our analytical abilities, and purchase assets in the market when the price at which they are selling is markedly below what we believe them to be worth. By sticking to our value investing guns, we can avoid the pitfalls of short-mindedness, avoid latent risks, and earn our clients satisfactory returns on their capital.
How are those moves calculated? Example of the Dow Divisor
The Dow Jones Industrial Average is computed by taking the average price of the 30 stocks that make up the index (constituents) and dividing that figure by a number called the Dow Divisor.
“The Dow Divisor is used to maintain the historical continuity of the index. It does this by factoring in the many changes that take place among the index constituents such as stock splits, spinoffs and changes to – or payments of – dividends going back to when the index was first introduced in 1896.
The Dow Divisor is adjusted to ensure that such events do not, in and of themselves, alter the true numerical value of the DJIA. Because of major changes that have taken place within the market historically, the value of the Dow Divisor has changed significantly over the years. For example, it was at 16.67 back in 1928, but was at 0.147 as of September 2019.” 1
If the sum of the prices of the 30 stocks that make up DJIA is 4,001, dividing this figure by the Dow Divisor of 0.147 would provide a level of 27,220 for the index. The Dow Divisor was 0.147 in Sept. 2019. Using this divisor, every $1 change in price in a particular stock within the average equates to a 6.8 (or 1 ÷ 0.147) point movement.
The Thirty Stocks That Make Up the DIJA
| 3M Diversified Industrials |
| American Express Financial Services |
| Apple Information Technology |
| Boeing Aerospace/Defense |
| Caterpillar Farm/Construction Equip. |
| Chevron Oil & Gas |
| Cisco Systems Computer Systems |
| Coca-Cola Beverages |
| Dow Commodity Chemicals |
| ExxonMobil Oil & Gas |
| Goldman Sachs Financial Services |
| Home Depot Home Improvement |
| IBM Information Technology |
| Intel Semiconductors |
| Johnson & Johnson Pharmaceuticals |
| JP Morgan Chase Financial Services |
| McDonald’s Food Industry |
| Merck Pharmaceuticals |
| Microsoft Information Technology |
| Nike Apparel |
| Pfizer Pharmaceuticals |
| Proctor & Gamble Household Goods |
| Travelers Insurance Financial Services |
| United Technologies Diversified Industrials |
| United Healthcare Healthcare |
| Verizon Telecommunications |
| Visa Information Technology |
| Walgreens Retailing |
| Wal-Mart Discount Retail |
| Walt Disney Media/Entertainment |
In 1896 the Dow Divisor was named after Charles Dow, an editor for the Wall Street Journal who partnered with statistician Edward Jones to form the first version of the DJIA. Since that time, the Wall Street Journal has been responsible for making sure that the Dow Divisor is adjusted properly to maintain the DJIA’s historical accuracy.
1 Source: Investopedia