We were met at the closing bell this afternoon by yet another record high on the Dow Jones Industrial Average. Which might make you feel pretty good about things. But maybe it shouldn’t.
“It’s a rough indicator of the health of the market,” says Kelly School of Business professor Scott Smart, “but there are some problems with the Dow as such an indicator.”
For one, the Dow is a very, very small sample. It’s 30 companies. And says Smart, “since it only looks at 30 stocks, there are obviously big portions of the market that the Dow doesn’t monitor or doesn’t capture.” Google isn’t there. Apple isn’t there. (I could keep this game going for a long time.)
Campbell Harvey from Duke has another reason you might want to do a little less Dow-gazing, “it is weighted in a very unusual way.” Unlike other indices, where the weight is the stock price times the number of outstanding shares, or the market cap, with the Dow, says Harvey, “the weight for each stock is essentially the stock price.”
To calculate the Dow, you pretty much need 4th grade math.
David Blitzer from S&P Dow Jones Indices explains, “You take the price of each stock and add up those 30 numbers.” And then you divide them by a divisor that’s right around 0.13. (When they replace a company on the Dow, they change the divisor to keep the Dow stable.)
And then you are done.
That’s the Dow. No complicated formula. No algorithms. No wonder more serious investors prefer the S&P 500 — which is up, but not yet setting new records.
BONUS AUDIO: Adriene continues the conversation with the S&P’s David Blitzer – more on how they calculate the index. Plus, have you heard any good Dow or NASDAQ jokes lately?
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