Wall Street's prime number

As a financial yardstick, the Dow Jones Industrial Average is somewhat of an anachronism, but it has its fans

For the record

April 09, 2000|By Brendan A. Maher | Brendan A. Maher,Contributing Writer

It is mysterious and imprecise, misnamed and arbitrary. But through boom times and depression, through its recent record-breaking gains and wild fluctuations, it remains the most widely recognized and religiously followed barometer of the U.S. stock market.

For those unversed in the ways of Wall Street, it is something of an enigma. For many savvy investors, it is a lumbering and antiquated construct. But it has held a prominent place in the world of finance for more than a century, longer than any other number of its kind.

But just what is this thing called the Dow Jones Industrial Average?

It is a number derived from adding and dividing the daily high share price of 30 high-grossing, "blue chip" companies. Thus it offers a yardstick -- or maybe mood ring -- by which to gauge the health of the U.S. stock market. But it is no longer an "average" by any real definition. Nor is it truly "industrial"; only about a third of the companies it lists represent the smokestack-and-heavy-machinery sector of the economy that once dominated it. Even the "Jones" in its name is a questionable addition.

The Dow got its start after Charles Henry Dow co-founded the publishing company Dow Jones & Co. in 1882 with the aid of fiery-tempered business reporter Edward Davis Jones and the funding of colleague Charles M. Bergstresser.

In 1884, in an edition of his Customer's Afternoon Letter, a two-page daily paper that would eventually grow into the Wall Street Journal, Dow chose 11 of the most successful industrial companies he felt represented the late 19th century economy (nine were railroads). He added the prices of a stock share for each and divided by 11, giving Afternoon Letter readers a quick reference point on how the nation's biggest publicly traded companies were doing. Twelve years later, he reworked his average, this time with a total of 12 companies, and named it the Dow Jones Industrial Average, linking Jones' name with it forever. (Bergstresser, unfortunately cursed with an unwieldy name, never received any credit he might have been due.)

Since then, the Dow has grown to a list of 30 companies, and is reworked regularly, with new companies added and others cast aside. Now as then, the editors of the Wall Street Journal reign as the Dow's high priests.

Fewer smokestacks

The "industrial" portion of the Dow's name has become increasingly anachronistic. Additions like McDonald's and Disney, Wal-Mart and Home Depot, Hewlett Pack-ard and Microsoft are a far cry from the primary producers who populated Dow's first Top 12, companies like American Cotton Oil, National Lead and Tennessee Coal & Iron. Only General Electric remains from the original list (although it has been removed and restored twice itself).

The addition of tech giants Intel and Microsoft in November 1999 -- replacing Chevron and Union Carbide chemicals respectively -- was unprecedented. Though adding these two high-grossing international companies may have seemed overdue, they were the first non-New York Stock Exchange companies ever listed, ending the Dow's traditional snub of the smaller, tech-based NASDAQ companies.

So, the Dow Jones Industrial Average has little to do with Jones and increasingly less to do with industry. Now let's try to decipher what is meant by "average."

A journalist through and through, Charles Henry Dow was neither a financier nor a mathematician. When he created the Dow, it was a simple, price-weighted average. He added the prices of one share for each of his original "top" companies and then divided by the number of companies: 12. Such a formula couldn't account, for instance, for the differing values of stocks being added and subtracted from the list, or for what are called stock splits, occasions when a company splits its stock, usually in half. Shareholders get twice as many shares, but at only half the price.

Simply figuring a new higher or lower stock price into Dow's basic equation without adjusting for the difference would greatly alter the average. So Journal editors came up with a new concept for the divisor, hoping to better reflect market complexities and retain "historical continuity."

As a result, over the years, the one-time divisor of 30 has shrunk ever smaller. Today, it resides at around 0.20145268, which explains in part how an "average" of 30 stock prices ranging from around 20 to nearly 150 could possibly equal 11,000.

A quirky institution

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