The Dow Jones Industrial Average (DJIA)
This post is the second part in a series covering the four major stock indices.
What Is the Dow Jones Industrial Average?
In the last post, I discussed the most referenced stock index – the Standard and Poor’s (S&P) 500. Another widely reported, and far older, index is the Dow Jones Industrial Average (DJIA), often referred to as “the Dow.”
In 1896, Charles Dow and his associate, statistician Edward Jones, both co-founders of the financial publishing firm Dow Jones and Company, created an index of industrial companies. This index was the second stock market index ever created, as Dow had created a transportation index twelve years earlier. If you’d like a quick, beginner-friendly overview, our YouTube short What Is the Dow Jones? . It breaks down the index in under a minute.
How the DJIA Is Structured
In its current form, the Dow consists of 30 “blue chip” companies. Blue chip companies are nationally recognized companies with long-established profit records. The components of the index are chosen by committee, which can replace companies in the index as conditions warrant.
Unlike the S&P 500, which weighs its components by market capitalization (share price multiplied by the number of outstanding shares) the DJIA weighs its components by price. The committee adjusts the prices of the components for events such as stock splits and spinoffs. For a deeper look at how the S&P 500 uses market capitalization to weight its components, see part one of this series. It’s titled Understanding Stock Indices: How the S&P 500 Shapes the Market.
Investment Strategies Based on the DJIA
There are several popular investment strategies based on the DJIA components. One popular strategy is called the Dogs of the Dow. This strategy involves investing in the ten stocks in the index with the highest dividend yields (dividend divided by stock price).
Like the S&P 500, there are numerous mutual funds and exchanged-traded funds (ETFs) that replicate the performance of the DJIA. These funds offer a low-cost way for investors to purchase stocks. However, funds replicating the DJIA are far less popular than funds that replicate the S&P 500.
Limitations of the DJIA
Although the DJIA is widely reported, it has some flaws as a proxy for the broader stock market:
- Stock price is an unreliable indicator of a company’s size, so price-weighted indices can under account for larger companies, such as Apple and Microsoft.
- Smaller companies can have a larger weight within the index than larger companies.
- The DJIA represents only 30 stocks, far fewer than the hundreds included in broader indices such as the S&P 500.
Historical Use as a Benchmark
While the S&P 500 is considered a superior proxy for the broader stock market than the DJIA, the S&P 500 was not widely adopted as a performance benchmark for stock fund managers until the 1970s. Before this, stock fund managers would often benchmark their performance against the Dow. For example, Warren Buffett, while managing his investment partnership in the 1960s, reported to his limited partners the fund’s performance relative to the Dow.
Index funds were not created until the mid-1970s, so there were no mutual funds that would allow investors to match the Dow. However, the relatively few stocks within the Dow and the fact that the index was price-weighted meant that investors could theoretically recreate the index by purchasing a single share of each stock in the index. This made the DJIA attractive as a way of benchmarking the performance of mutual fund managers.
Why the DJIA Still Matters
Despite its flaws, the DJIA remains alongside the S&P 500 as a widely-cited proxy for the broader stock market.
Summary:
The Dow Jones Industrial Average (DJIA) is one of the oldest and most widely cited stock indices. Created by Charles Dow and Edward Jones in 1896, it tracks 30 blue-chip companies and is weighted by stock price rather than market capitalization. While popular, the DJIA has key limitations — including its small number of components and price-weighted methodology — making it a less accurate proxy of the overall stock market than the S&P 500. Despite this, the Dow remains a recognizable benchmark with historical relevance for investors and fund managers alike.
Key Takeaways:
- The DJIA was created in 1896 and is one of the oldest stock indices in existence.
- It tracks 30 blue-chip companies chosen by committee.
- Unlike the S&P 500, it is price-weighted, not market-cap weighted.
- The DJIA has several limitations, including underrepresenting large companies and covering too few stocks.
- Historically, the Dow served as a key benchmark before the S&P 500 became dominant in the 1970s.
- Despite flaws, the DJIA remains a widely cited measure of the U.S. stock market.
