The Dow Jones Industrial Average (^DJI) is one of the U.S. stock markets oldest metrics dating back to 1896. The Dow Jones Industrial Average consists of 30 very large companies that have generally existed for a long time and have monolithic reputations as corporate giants with significant economic influence.
Some of these companies include General Electric (GE), Alcoa (AA), and Coca Cola (KO). Like other indexes, the Dow Jones Industrial Average takes into account the proportion of each company in determining the mathematical influence each company has on the index value. By doing this the index managers are ensuring a more accurate representation of the combined performance of all the companies.
• Why the Dow Jones Industrial Average is Used:
The Dow Jones Industrial Average is used to measure both corporate and economic performance. Since the companies listed in the index are from a wide variety of economic sectors, the DJI provides analysts, fund managers, investors and economists with a useful indicator for overall stock market performance. The Dow Jones is considered a financial barometer of broad based market performance and data has been collected on this particular index for over 80 years.
• How the Dow Jones Industrial Average is Used:
Often, the value of many company stock prices are correlated using statistical analysis to the Dow Jones Average. This value is called a 'Beta' and is the measurement of how closely an individual stock trends up or down in tandem with the Dow Jones Industrial Average and/or other indexes. The DJI provides people with a quick snapshot of market performance of large companies and possibly many more companies that are correlated with them for a given business day. In this sense it is an assessment tool of general market performance and individual stock performance as measure by the Beta statistic.
• Mathematical Considerations of the DJI:
The Dow Jones Industrial Average has something many other indexes do not and that is 'consistency'. In other words, because the index only uses price weighting and not capitalization weighting, it does not take into account growth in each companies equity directly. For example, if a company has a 2 for 1 stock split and after a month the stock prices increases 10% the DJI will reflect the 10% increase in stock price but not the increase in equity generated from the stock split.
What's more, if the price of the stock declines due to the split which is more likely this will negatively affect the performance of the index average. Usually however, savvy analysts and observers may have the knowledge and sense to factor these financial occurrences into their analysis of the DJI performance.
Another concern is since there are only 30 companies in the DJI and over 9000 publicly traded companies in the U.S. the index is perhaps an understatement. The virtue of the DJI rests with the size of its component companies and the fact many of these other publicly traded companies have stock prices that are statistically related to the DJI.
The Dow Jones Industrial Average is a key market index that measures market performance as a weighted average of its component parts. These component parts are companies that comprise some of the largest in the United States and provide a representational assessment of a larger market performance.
It is likely the Dow Jones Industrial Average will continue to be used in the future because of the importance of the companies within the index. While the importance of this index may decline over time and as other index are relied more heavily upon, the Dow Jones Industrial average will continue to have a relative importance and representational merit in regards to stock market performance and metrics.
Sources:
1. http://stocks.about.com/od/evaluatingstocks/a/beta120904.htm
2. http://en.wikipedia.org/wiki/Dow_Jones_Industrial_Average
3. http://www.djindexes.com/mdsidx/?event=showAverages
4. http://www.finweb.com/investing/market-indexes-the-dow-jones-industrial-average.html
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