Aug 19, 2011

What is the Dow Jones

Charles Dow was a legendary newspaper mogul and co-founder of The Wall Street Journal.  The average is named after Dow and one of his business associates, statistician Edward Jones. In 1896, Dow created the first version of the Dow Jones Industrial Average. The idea was to monitor the health of the business sector by tracking the performance of the country’s 12 largest firms. The Dow was originally measured in dollars, and accountants averaged the 12 stock prices. The first Industrial Average on record was $40.94. When the firms were doing well, that average went up; when they performed poorly, the Dow went down.

The measuring system has become more sophisticated over the years. The modern index includes 30 companies, and the Dow has to account for things like stock splits and spin-offs.  The value of the Dow is not the actual average of the prices of its component stocks, but rather the sum of the component prices divided by a divisor, which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index. Because of these adjustments, the Dow is now measured in points rather than dollars. A single dollar increase in any of its current members’ share prices causes the Dow to rise by about seven points.

A three-person committee, including the managing editor of The Wall Street Journal, handpicks the companies, looking for stocks with strong reputations, solid growth, and interest from a broad pool of investors. Of the original 12 companies selected, only General Electric is still in the pool. The 'industrial' in the average’s name is a throwback to the original companies. The Dow remains one of the best indicators of the overall health of the U.S. economy. Lately, the Dow is slipping, but hopefully will never get back down to 40.94.