What Does a Dow Jones Point Drop Mean?

by Karen Farnen

The Dow Jones, or Dow Jones Industrial Average, is the best-known index of U.S. stocks. Its creation in 1896 gave investors the first tool to tell whether American stocks prices were generally increasing or decreasing. The composition of the index and its method of calculation have evolved over time. However, a point drop in the Dow Jones still indicates a general fall in U.S. stock prices in the eyes most investors.

General Makeup

Point drops for the DJIA reflect only changes in selected blue chip stocks in certain types of industrial companies. The DJIA excludes the transportation and utility sectors, which have their own Dow indexes. The DJIA has grown to 30 stocks and includes U.S.-listed companies with good reputations and solid growth. Although the actual stocks can change, the Dow is slow to include newer types of businesses. For example, Google and Apple are not in the index at publication.

Components

A drop in the DJIA reflects only a change in price for stocks in the index, and not for any other companies in similar businesses.The largest components in the DJIA are industrials and technology, which together make up nearly 40 percent of the allocation at publication. Other segments are consumer services, consumer goods, energy, finance, health, telecommunications and materials. American Express, Chevron, Hewlett Packard, Home Depot, Pfizer and Walt Disney are among the Dow Jones 30.

Calculation Method

Charles Dow originally computed the DJIA by adding the prices of all stocks and dividing by the number of stocks. However, now the committee uses a divisor to make up for irregularities such as stock splits. For example, when each share of a stock splits into two, the total value remains the same. A $200 share becomes two $100 shares. The index is weighted for stock price but ignores market share. This means a 5-percent drop in price in a high-priced stock has greater impact than a similar drop in a cheap stock, regardless of total company value.

Symbolic Meaning

The Dow Jones traditionally represents the pulse of the American economy to the world, according to Jeffrey R. Kosnett, senior editor of "Kiplinger's Personal Finance." A large point drop in the Dow is the symbol of U.S. stock market distress for most investors, he believes. News headlines feature changes in the DJIA, rather than the S&P 500, Wilshire 5000 or other broader indexes. Even though it covers only 30 companies, the DJIA has correlated with the S&P 500 more than 95 percent of the time over the last 25 years and into the 2000s.

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