How’s The Dow Doing?

“No one would build a stock market index that way today….it’s a crazy way to measure the market.” –Jeremy Siegal, Professor, Wharton School of Business

06-01-2021

Siegal is referring to the Dow Jones Industrial Average (DJIA). It’s probably the most cited index to try to gauge how the overall market is doing and it’s more than showing it’s age. It celebrated its 125th birthday last week. At one point, the index probably had some relevance but that ship has long sailed.

Truth be told, the DJIA is a flawed index. It’s not a good representation for how the overall market is doing.

Why? Well, first of all it consists of only 30 companies with sector weightings that are not a good representation of the overall market.

Secondly, the index is weighted by stock price not market capitalization. I believe this is the only index in the world that is constructed this way. It’s absolutely absurd. For example, Goldman Sachs which has a share price around $365 is the second largest company in the DJIA. Apple with a share price of around $127 is in the middle of the pack of the thirty companies. However, Apple’s total market capitalization is over 17 times that of Goldman. The individual share price of a company is totally meaningless. It’s the overall market capitalization that determines the true size of a company.

Lastly, the DJIA excludes reinvested dividends in its value. The compound growth of reinvested dividends makes up a substantial part of a stocks long-term return and should not be excluded in the value of the index.

So, the next time someone says…”How’s the Dow doing?”… you can answer that it’s an irrelevant index that’s not a good representation of the overall market. The S&P 500 or the Wilshire 5000 are much better representations for how the overall markets are doing. In fact, the Wilshire 5000 includes every investable U.S stock.