The Dow we know and love, but don't really use

The Dow has virtually no investment market share — the $33 billion tied to it as of year-end 2013 is barely a rounding error compared with the $1.87 trillion tied to the S&P 500 — but boy, does it have mindshare. What will happen when Apple joins on Wednesday night?

By InvestSMART · 17 Mar 2015

By InvestSMART ·
17 Mar 2015

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One of the great disconnects of the financial world involves our best-known stock market indicator — the Dow industrials.

The Dow has virtually no investment market share — the $33 billion tied to it as of year-end 2013 is barely a rounding error compared with the $1.87 trillion tied to the S&P 500 — but boy, does it have mindshare. Ask “How is the market doing?” and most people (including me) will refer to the Dow, not the S&P.

We will see the mindshare phenomenon at work later this week, with the Dow getting plenty of attention as it adds the world’s most valuable company, Apple, after the market closes Wednesday and kicks out one of the great old names of the past, AT&T. The Dow will go through additional contortions because its highest-priced component, Visa, is splitting its stock 4-for-1. All of this will be in effect when the market opens Thursday morning.

The S&P — full name, Standard & Poor’s 500-stock index — measures the market value of its 500 stocks. But the Dow — full name, Dow Jones industrial average — adds up the prices of its 30 stocks and then divides the total. Lots of people call the Dow an index, but it’s really an average. And that makes a huge difference.

For example, some numbers-crunchers at Bloomberg calculated that had the Dow added Apple rather than Bank of America in 2008 and had Apple not split its stock 7-for-1 last year, the Dow would now be about 22,000. (An amusing sidelight: BofA replaced Altria just in time to get whacked by the financial crisis; it was ousted from the average in 2013, replaced by Goldman Sachs.)

For reasons I’ll explain some other time, each dollar move in any of the 30 Dow stocks moves the average by 6.42195 points. To give you an extreme example, for the Dow a $1 move by Travelers’ 331 million shares is equal to a $1 move in General Electric’s 10.04 billion shares. If GE rises a buck and Travelers falls a buck, the S&P, which measures stock market value, would show a $9.7 billion gain. The Dow, by contrast, would be flat.

This bizarre situation helps explain why, although everyone knows the Dow, almost no one invests in mutual funds or exchange-traded funds tied to it. The nation’s biggest fund operator, Vanguard, says its investors have about $400 billion tied to the S&P, but not a penny tied to the Dow.

Now, let me show you what the Dow has to go through to keep the average at the same level when it changes components or one of its stocks splits.

Let’s say that the Apple-for-AT&T substitution and Visa’s stock split had taken place after Friday’s market close.

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Frequently Asked Questions about this Article…

Why is the Dow Jones Industrial Average so well-known if few people invest in it?

The Dow Jones Industrial Average is widely recognized because it has significant mindshare as a stock market indicator. Many people refer to the Dow when asking about market performance, even though it has virtually no investment market share compared to the S&P 500.

How does the Dow Jones Industrial Average differ from the S&P 500?

The Dow Jones Industrial Average is an average of the prices of its 30 stocks, while the S&P 500 measures the market value of its 500 stocks. This difference means that the Dow is more influenced by the price changes of individual stocks, whereas the S&P 500 reflects overall market value changes.

What impact do stock splits have on the Dow Jones Industrial Average?

Stock splits can significantly affect the Dow Jones Industrial Average because it is price-weighted. For example, Visa's 4-for-1 stock split required adjustments to keep the average consistent, as each dollar move in a Dow stock affects the average by a specific number of points.

Why do investors prefer the S&P 500 over the Dow Jones Industrial Average?

Investors prefer the S&P 500 because it provides a more comprehensive view of the market by measuring the market value of 500 stocks. This makes it a more reliable indicator for mutual funds and exchange-traded funds, unlike the Dow, which is an average of only 30 stocks.

How does a change in the Dow's components affect its average?

When the Dow changes its components, such as replacing AT&T with Apple, adjustments are made to maintain the average at the same level. This ensures that the index remains consistent despite changes in its stock lineup.

What would have happened if Apple was added to the Dow in 2008?

If Apple had been added to the Dow in 2008 instead of Bank of America, and if Apple hadn't split its stock 7-for-1, the Dow would be around 22,000 today, according to calculations by Bloomberg.

Why is the Dow considered an average and not an index?

The Dow is considered an average because it adds up the prices of its 30 stocks and divides the total, rather than measuring the market value like an index such as the S&P 500. This distinction affects how the Dow responds to price changes in its components.

What is the significance of the Dow's price-weighted nature?

The Dow's price-weighted nature means that each dollar move in any of its 30 stocks affects the average by a specific number of points. This can lead to situations where large price changes in high-priced stocks have a disproportionate impact on the Dow compared to the overall market value.