NEWSDAY STOCK MARKET GAME

Understanding the Dow Jones Industrial Average

"The Dow Jones Industrial Average rose to a record high today," announced the TV reporter. You have probably heard or read similar reports. But what is the Dow Jones Industrial Average, and why is it in the news so often?

The "Dow," as it is often called, is the most popular indicator of what the stock market is doing. People pay close attention to it because it measures the level of stock prices.

The Dow Jones Industrial Average is the world's oldest stock market indicator. Charles H. Dow invented it in 1884. He was the first editor of The Wall Street Journal newspaper and a founder of Dow Jones and Company, Inc. He calculated the first Dow average by using stocks from 11 large and prosperous companies. At that time, most of these companies were railroads. So with pencil and paper in hand, Charles Dow added the stock prices of the Union Pacific, New York Central, Northern Pacific and other railroads. Then he divided by 11 and produced the first stock market indicator.

By 1896, the Dow had expanded to 12 companies, but railroads were no longer included. American manufacturing companies had grown so rapidly that they made up all 12 of the stocks in that year. The words industrial and manufacturing have similar meanings, so the average was called the Dow Jones Industrial Average.

Today, Dow Jones and Company, Inc. quickly calculates the average by computer and flashes it around the world. The indicator now includes 30 companies, and although it is still called the Dow Jones Industrial Average, some of the companies are other types of businesses.

The Dow Jones Industrial Average that you see in the news isn't given in dollars and cents. After the prices of the 30 different stocks in the Dow are added together, the sum is not divided by 30, as you would do when you calculate an average. Instead the sum is divided by a special number called the divisor. The reason for this special divisor is too complex to explain here. Just remember that because this special divisor is used, the Dow Jones Industrial Average is not quoted in dollars and cents. For example, if the Dow opens at 7730 and closes at 7750 at the end of a trading day on the New York Stock Exchange, it has not risen 20 dollars.

Some people criticize the Dow because it includes only 30 of more than 3,000 stocks listed on the New York Stock Exchange. These 30 companies, however, account for more than 25 percent of the market value of all stocks traded on the New York Stock Exchange. But other measures are available for investors to follow. One is the Dow Jones Transportation Average, which includes 20 different stocks of railroad, trucking and airline companies. Another is the Dow Jones Utility Average, which includes 15 electric, gas and other utility companies.

Other stock market indicators are also popular and useful. One is the Standard & Poors 500 Index, which tracks the prices of 500 widely held common stocks. Others are the New York Stock Exchange Index and the NASDAQ-OTC Price Index. Investors who look at all these indicators have no trouble finding out the level of stock prices. By closely watching changes in these indicators, investors can judge whether stock prices are going up or down.

Q & A's About the DJIA

Q What stocks are in the Dow Jones Industrial Average?
A The DJIA consists of 30 stocks. Currently they are:

ALCOA
Altria Group Inc.
American Express Co.
Amer. Int'l Group Inc.
Boeing Co.
Caterpillar Inc.
Citigroup Inc.
Coca-Cola Co.
DuPont Co.
Exxon Mobil Corp.

General Electric Co.
General Motors Co.
Hewlett-Packard Co.
Home Depot Inc.
Honeywell Int'l Inc.
Int'l Bus. Mach. Inc.
Intel Corp.
Pfizer Inc.
J.P. Morgan Chase & Co.
Johnson & Johnson

McDonald's Corp.
Merck & Co.
Microsoft Corp.
3M Co.
Procter & Gamble Co.
SBC Communications
United Technologies Corp.
Verizon Comm.
Wal-Mart Stores Inc.
Walt Disney Co.

Q How are stocks picked for the Dow Jones Industrial Average?
A The editors of The Wall Street Journal select the components of the industrial average. They take a broad view of what industrial means. In essence, it is almost any company that isn't in the transportation business or isn't a utility (because there also are Dow Jones Averages for those kinds of stocks). In choosing a new company for the DJIA, they look among substantial industrial companies with a history of successful growth and wide interest among investors. The components of the DJIA are not changed often. It isn't a "hot stock" index, after all, and the Journal editors believe that stability of composition enhances the trust many people have in the averages. The most frequent reason for changing a stock is that something is happening to one of the components, such as a takeover. Whenever one stock is changed, the rest are reviewed.

Q How is the Dow Jones Industrial Average computed?
A Originally, Charles H. Dow simply added up the prices of the stocks in his average and divided by the number of stocks. But over time the divisor has been changed to preserve historical continuity. The most frequent reason for such an adjustment is a stock split. Suppose a company in the DJIA issues one new share for each share outstanding. After this two-for-one "split," each share of stock is worth half what it was immediately before, other things being equal. But without an adjustment in the divisor, this split would produce a distortion in the industrial average. Here is an example: Assume three stocks are selling at $5, $10 and $15. Their average price is $10. Now assume the $15 stock is split three-for-one, and the stock subsequently sells for $5. Nothing has happened to the value of an investment in these shares but the average of their prices now is $6.67, not $10. An adjustment must be made to compensate so that the "average" will remain at $10. This can be done in various ways mathematically, but at Dow Jones it is handled by changing the divisor, or the number that is divided into the total of the stock prices. In this example, the new divisor would be 2 instead 3. Most changes in the divisor are downward.

Q Why is the DJIA the most-quoted market indicator in newspapers and on TV?
A Because it is the oldest market indicator, it also was the first to be quoted by other publications. This practice became habit when Wall Street earned at least a mention in the general news each day, and habit became tradition by the time the post-World War II bull market galvanized the nation's attention. The industrial average became the indicator to cite if you were citing only one. Besides longevity, two other factors play a role in its widespread popularity: It is understandable to most people, and it reliably indicates the market's basic trend.

Q Does the DJIA predict where the stock market is going?
A No. Some people make predictions about where the stock market is headed based in part on their interpretation of DJIA movements, as well as movements of the transportation and utilities averages. But indexes don't predict anything. They are doing their job if they accurately reflect where the market has been.

Q How high can the DJIA climb?
A As high as it wants to. There aren't any mathematical limitations to the industrial average's ascent. But no matter how large the numbers, it is the market's trend at any given time that is important.

Understanding the Dow Jones Industrial Average

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