The Dow Jones Industrial Average - DJIA
The Dow Jones Industrial Average (DJIA) is one of the most popular stock indexes due to its long history. It has been computed since 1896 when it covered 20 "blue-chip" corporations. In 1928 it was expanded to 30 stocks.
The DJIA is a price-weighted stock index, or at least it began that way. This means that each company carries a weight in the index proportional to its stock price. Originally it was calculated by simply adding up the prices of the Average's 30 stocks and then dividing by 30. This means that if an investor were to hold a portfolio with equal amounts of shares of each of the Average's stocks, the percentage that the DJIA increased or decreased would be equal to the percentage that the portfolio increased or decreased.
| Stock | Initial Price | Ending Price | Shares Outstanding | Initial Market Value | Final Market Value |
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| A | $40 | $50 | 10 mil | $400 mil | $500 mil |
| B | $100 | $90 | 2 mil | $200 mil | $180 mil |
| TOTAL | $140 | $140 | 12 mil | $600 mil | $680 mil |
|---|
For example, the above table shows the stocks of two companies, A and B. Given the initial value of the two stocks, a price-weighted index would be 70 since ($40+$100)/2 = 70. After the stocks changed value, the index would still be 70 since ($50+$90)/2 = 70. Note that although the index hasn’t changed, total market value of the two companies has increased.
Calculating a price-weighted average becomes trickier when a stock splits or when a company within the index is replaced by a different company. The index needs a seamless transition so that such changes don’t affect its ability to compare historic prices. To deal with such changes, price-weighted indexes like the DJIA use weights.
Using the previous example, let’s now assume that Company B’s stock splits. The following table shows the new results.
| Stock | Initial Price | Ending Price | Shares Outstanding | Initial Market Value | Final Market Value |
|---|
| A | $40 | $50 | 10 mil | $400 mil | $500 mil |
| B | $50 | $45 | 4 mil | $200 mil | $180 mil |
| TOTAL | $90 | $95 | 12 mil | $600 mil | $680 mil |
|---|
You can see that although the market value is identical as the previous example, the index would now be lower since the price of the actual stock is lower. To prevent this shift in the index, a price-weighted index will multiply Company B’s stock price by 2 in order to preserve its original value.
See the List of the DJIA.
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