I remember how I used to look at the daily movements of the Dow Jones Industrial Average (DJIA). That was before I started working in finance. Why? Because that is what they showed on tv. It’s the main index they would report on.
In a sense, I understand. It’s a very easy index to understand. It includes 30 of the biggest companies in the world. Companies such as Walmart (NYSE:WMT), Microsoft (NASDAQ:MSFT), Walt Disney (NYSE:DIS), JP Morgan Chase (NYSE:JPM) and Coca-Cola (NYSE:KO).
As I learn more about finance though, my opinion is changing.
The DJIA Is IrrelevantIt means very little. First off, having only the biggest blue chips doesn’t seem like a great way to build an index. That would be a matter of preference though and it’s certainly possible to argue that having an index of the biggest blue chip names has value.
What No One Can ArgueI personally think it makes no sense to have an index that is price-weighted. If you’re not aware. When the Dow Jones increases by the $8.24, that means that if you add up the daily gains and losses of the 30 stocks, you will get $8.24. What does that mean? The DJIA has not added companies such as Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL) because of their high price. Why? If Google and its $800 price were added to the index, it would be worth around 6% of the index.
For example, imagine a day where 28 stocks in the index do not move. Google drops by 2% and Bank of America (BAC) increases by 100%..! The DJIA would actually be down for the day!!!!
That makes no sense to me.
I personally look at broader market cap weighted indexes such as the S&P500 which give a much more accurate picture?
Why does the DJIA still exist? It’s well known, it has a history, a tradition, etc.