The Dow is a ridiculous stock index. It doesn't adjust for inflation, and - more importantly - just looks at the stock price, not the underlying market cap. So if Caterpillar (market cap
49.44B) rises 5$ from 80 to 85, the Dow rises 32 points. If Exxon Mobil (market cap 362 Billion) rises from 86 to 91, the Dow rises the same 32 points, even though the first rise means CAT grew only in 3,3 billion Market cap, while XOM grew 20,95 Billion.
The Dow is price-weighted because it was started before computers. Add 30 prices and divide by adjustment factor is the easiest to calculate. Also, it was the first index, before people realized other methods are more accurate.
Now it has to stay that way for backward compatibility.
It is backward-compatible, because they adjust the divisor to compensate, so that the index value pre-rebalancing is the same as the index value post-rebalancing.
If they never adjusted the list of stocks, it would eventually become irrelevant as stocks go bankrupt or are acquired. Only 1 current Dow member was in the index in 1907 (GE), and 4 current Dow members were in the index before 1939 (XOM, PG, DD).
Agreed - a price-weighted index like the DJIA doesn't make much sense for describing the aggregate behaviour of the constituents, even if it does attempt to adjust for stock splits.
A market-cap weighted index like the S&P 500 is probably a better measure.
The correlation between SPX and the DJIA will generally be quite high, because sampling 30 stocks (and generally those with the biggest market caps) gives you a good estimate/representation.
As a result, over short periods of time, the spread between the two will be relatively small.
Over long periods of time however, the spread can be significant. See the following:
Yes, the calculation of the Dow Jones is a complete joke, but, funnily enough, it has tracked the fairly sensibly calculated S&P 500 surprisingly closely over time.
Its popular in the media - but it isn't really used as a benchmark. DIA, the Dow Jones Industrial Average ETF has $12bn AUM whereas SPY, the market-cap weighted S&P 500 etf has $189bn AUM... and probably significantly more if you look at all the "passive" money...
Uh assuming you are serious the parent poster obviously understands this. The point is that it is absurd to have an index where if the total market cap of the tracked companies goes down, the index can go up. This has nothing to do with the returns of buying or selling any particular stock.
One way of looking at the DJIA - If you place $1000 into each of the companies underlying it, the DJIA will reflect your gain/loss in investment. If you tried to weight the index based on the underlying market cap of each of the companies, you wouldn't get a correct assessment of the value of your investment.
The one thing the article fails to mention is that the addition of Apple will coincide with a 4:1 stock split in Visa[0]- the index's highest priced (and thus highest-weighted) holding.
Although the addition of Apple had been anticipated, Visa's split was definitely a catalyst. Had they not added Apple, the technology sector within the index would have dropped significantly, in line with Visa's split. The addition of Apple will minimize the impact.
That sounds utterly ridiculous. Why would they base anything off the price of the stocks? If they all issue a 2:1 split, then what, the index drops by half?
Why would anyone use such a measurement? Why would anyone continue to cite such a measurement? It makes me wonder what other widely-used things are shams but I lack the knowledge to judge.
It's not terribly rare that a stock splits in the Dow.
The index value itself doesn't change on account of the split (that would be ridiculous). Visa's weight will drop, and every other stock in the index will increase accordingly. They use an index divisor to maintain the current level of the index when corporate actions like this occur: http://www.investopedia.com/terms/i/indexdivisor.asp
At this point, the Dow is only cited because "it's been around forever." That, and Dow Jones is owned by News Corp. So of course the media wants to keep promoting its own subsidiary.
I wonder who actually does care about the Dow? Are there actually a lot of investors that don't know any better? Or is it just people who think the stock market is important (itself questionable) but don't know anything about it?
> Or is it just people who think the stock market is important (itself questionable) but don't know anything about it?
As a kid, for many years, the first and only exposure I had to the concept of the stock market was the clockwork reference to DJIA on public radio or tv. I think the founding of the exchange might have been mentioned in school, too (and not much else).
So, later in life, when I wanted to understand things better, I started reading about the Dow and picking it apart. It was an entry point for me; I assume it must have been for many others as well.
Now that I have more knowledge, I question - as you apparently do - whether any of it is worth getting too deeply involved in for the average person. Still, I'm glad I know more about it now, and I do think we need far better financial literacy built into our school system.
Interesting chart! While this does show the potentially drastic impact that one company can have in a 30-constituent index, the S&P 500 (with its market-cap weighting) is not completely immune from one company potentially dominating as well.
For example, IVV, an index ETF that tracks the S&P 500, currently has > 4% of its assets in AAPL[0], due to Apple's immense market cap.
This post[1] from back in 2012 looks at how different things would have been for all the DJIA-referencing articles if Apple had been included in the average all along, instead of Cisco. (It also points out ridiculousness of the index that makes this possible.)
For a time before computers it made sense, but it's amazing that it's remained relevant this long. These days, there's no real reason to even use the S&P 500 as a market proxy given the existence of more comprehensive indexes, but at least it has a logical basis.
The DJIA is so flawed I'm surprised this is news. A dollar change to an $800 stock affects the DJIA just as much as a dollar change tn a $30 stock so the DJIA is nearly meaningless.
I don't think this is true -- the index rises in proportion to the stock's price. The stock price of company A would have to rise $26.66~ to incur the same index increase as company B.
It does ignore market cap though. So if company A's market cap was $800M but company B's market cap was $3M, and the shares rise as I explained, they'd still have the same impact on the DJIA. That's why it's flawed.
However, it's a really good indicator of investment performance. Just not necessarily market or economic performance.
It is 100% true. The way the DJIA is computed is by summing the share prices of each of the 30 constituents and then dividing by a magic constant (the divisor). When you think about it this way it's obvious that a $1 increase in share price for any of the constituents will have exactly the same impact on the value of the DJIA.
Its hard to quickly find an exact number, but the market cap of ETF's / mutual funds that follow the DJIA is pretty small (for understandable reasons) - the largest I can find is $12B (DIA)
> A dollar change to an $800 stock affects the DJIA just as much as a dollar change tn a $30 stock so the DJIA is nearly meaningless.
You'd have to look at how many outstanding shares there are. A stock valued at $800 a share might appear stronger at first, but if the $30 per share stock has 30 times more outstanding shares... that's a stronger stock.
I might be wrong, but I think the original commenter was more or less stating this, but just in a different manner.
The fact that a $1 change in a $800 stock has the same effect as a $1 change in a $30 stock is because the index is price-weighted. This is arguably not a good measure of the overall behavior since it ignores the market cap. (Which I believe was your point)
A market-cap weighted index (like the S&P 500) would overcome these issues.
The DJIA ignores market cap and just uses share price. So, # of outstanding shares has no effect. Stock splits do not count as changes in share price though.
> Your wrong.
The DJIA ignores market cap and just uses share price.
I'm fairly certain I made no claims this was how the DJI currently behaved -- I was making the point that a better market valuation could be achieved by examining the market cap in addition to share price.
Uhh, sorry no idea how else to parse what you wrote. Could you clarify?
In response to "> A dollar change to an $800 stock affects the DJIA just as much as a dollar change tn a $30 stock so the DJIA is nearly meaningless." You say "You'd have to look at how many outstanding shares there are. ..."
Edit: Unless you assumed they meant 1$ change in market cap, but as he was actually discribing the way the DJIA works assing he was wrong if you know how it works seems odd.
PS: Sure, we can make a new index using different math, but at that point were simply talking about something else not the DJIA. What's really surprizing is how useful the DJIA is as a simple indecator of market trends that never get's that big. IMO, 1000 * Log(market basket of stocks) might be just as handy, but they pick stocks in part as good proxy for the ecnomy so the DJIA is more useful than you might think.
Given the relatively recent passing of its founder, a founder who remained so intensely and directly and involved with new product development up until the very end, Apple's stock is so bizarrely difficult to value right now that I can't fathom making it part of a bellwether indicator like the DJIA.
I used to be puzzled about Apple's stock price but then I notice that it really tracks revenue and the product cycle, that is, it really is earnings driven, and it is volatile because the earnings are volatile.
I realize this is unpleasant, but I firmly believe it needs to be said: there is an element of volatility inherent in the firm at least until it goes through a major product launch without Steve Jobs.
Is the watch major enough? If so, we'll see pretty soon. Personally, I'm not optimistic, although I don't know that Steve would have made any difference.
Thinking about the watch recently: If it doesn't become the new iPhone or iPad, it's not the end of Apple. They'll still sell in the 7-8 digits, with a profit margin upwards of 25%.
I don't know if it will be successful, but they've got a few things in their corner: Talent they've brought in to work on it from the fashion industry, Apple's brand name and marketing, economies of scale, their app ecosystem. I personally think that the current offering of smartwatches available is fairly underwhelming. Maybe Pebble and the rest have just been whetting everyone's appetite for watches that have better all-around execution? (Hardware, design, integration, etc.)
I agree that Apple could withstand the watch being a total flop (for Apple) without any real trouble, and they'll probably outsell other smartwatches by a comfortable margin. But I have a really hard time imagining it reaching anything like the same scale as, for example, the iPad, or staying sustainable over the long term. Apple is good at taking market segments where there's demand for a good product, and existing products are lacking, and finally getting it right. I just don't see that demand for a watch.
I think so, but it's hard to accurately remember that sort of thing in hindsight. I definitely remember thinking tablets in general were cool, and hoping Apple would finally make one worth using. I find smartwatches profoundly uncool and can't see regular people buying them, although I certainly could be wrong.
NPR's Planet Money has a great episode on the DJI: http://www.npr.org/blogs/money/2013/03/12/174139347/episode-...