Upbeat music plays throughout.
Narrator: You've likely heard someone on the news say something like, "the Dow is up 80 points," or "the Dow is down 50 points," but what does that mean?
They're talking about the Dow Jones Industrial Average. The Dow is an average of the price of a selected group of stocks, also known as an index. Rather than a micro-look at just a single company's performance, an index helps investors see the overall performance of the broader market.
On-screen: An image of Charles Dow appears with his name next to him in the bottom left corner. Underneath is the date range 1851 – 1902, representing the year he was born and the year he passed away.
Narrator: The Dow was first created by financial journalist Charles Dow in 1896, and it included just 12 companies.
Animation: A header appears that says "Dow Jones Industrial Average – 1896". Underneath this header names of the original companies listed in the Dow Jones begin to appear. These companies, listed in descending order, are: American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling and Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal and Iron, U.S. Leather, and U.S. Rubber.
Narrator: Over time, the index grew, and as of 2022, the Dow included 30 companies from nine different sectors.
The 30 companies in the Dow are considered market leaders in their sectors. If an individual company is underperforming in its sector, a committee may consider replacing it with another.
For example, in 2018, GE—the last remaining original company in the Dow—had been underperforming its sector for several years. As a result, GE was removed to make room for the drugstore chain, Walgreens.
Animation: A pie chart appears. A list of nine categories under the header Sector Breakdown emerges next to it. These categories are: Industrials, Financials, Communication Services, Information Technology, Health Care, Consumer Discretionary, Energy, Materials, and Consumer Staples.
Including major companies in different sectors is meant to paint a picture of the overall market and signal to investors if a portion of the economy is weakening.
Keep in mind that the stock market is not the economy. But historically, the Dow has generally tracked U.S. gross domestic product, an overall measure of economic activity.
While the Dow is meant to provide a snapshot of the stock market's performance, certain features may skew its outlook.
First, the Dow's 30 companies are a pretty narrow slice of the U.S. stock market, which contains thousands of publicly traded companies. Having such a small view could distort what the broader market is signaling.
Next, the Dow is price weighted. This means companies with a higher share price have a larger effect on the average, regardless of the company's actual size. For example, Goldman Sachs was trading around $177 on May 12, 2020, while Pfizer was around $37. However, Pfizer's' market capitalization was $207 billion compared to Goldman's $60 billion. This means that even though Pfizer is over three times larger by market cap, Goldman Sachs carries more weight in the index based on its share price.The Dow isn't the only popular index out there; another popular one is the S&P 500®, which features 500 companies from every sector. The S&P 500 is market-cap weighted instead of stock-price weighted. This means larger companies with a higher market cap have more influence over the index than smaller companies.
The difference between price and market-cap weighting was obvious in early March 2019, when Boeing's shares dropped 14% following its grounding of the 737 Max. Because Boeing had the highest share price in the Dow at the time, its fall dragged the Dow with it. Meanwhile, the S&P 500 rose because the broader market was performing well.
So, while the Dow can serve as a quick gauge of the U.S. stock market, it can't tell you everything, which is why it's important to look at multiple indexes in order to get a more complete picture.
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