The Dow Jones Industrial Average was created by a financial journalist named, most appropriately, Charles Dow. Though Charles Dow created his first stock market average in 1884, this initial index was comprised of only 11 stocks, most of which were railroad companies. It wasn’t until May 26, 1896, that Charles Dow first published the Dow Jones Industrial Average. On this day in 1896, the Dow consisted of 12 companies and stood at 40.94. Over the coming months, the Dow then declined to what would become its historic low of 28.48 on August 8, 1896. The next major milestone occurred on October 4, 1916, when the Dow was increased to 20 stocks from its original 12. It wasn’t until October 1, 1928 that the Dow was modified to consist of thirty stocks as it does to this day.
Back in 1896 Charles Dow also created the Railroad Average which in 1970 was subsequently renamed the Transportation Average. The Utilities Average was created in 1929. As a result, the Dow Jones Industrial Average is intended to be representative of the entire United States economy except for the transportation and utilities sectors.
In the beginning, the DJIA was a simple average to calculate. Simply sum the stock price of each company and divide by the number of companies. Stock splits and other market changes make a basic average an impractical way for an index to be calculated. Not adjusting the average for stock splits and other market changes would create a devalued Dow. To keep historical continuity and allow for a comparison to be made to past Dow values, the maintainers of the Dow (i.e. S&P Dow Jones Indices) modify the index with a divisor. The divisor is simply a number which takes stock splits and other market changes into account. So in order to calculate the current value of the Dow, one must sum the stock price of each company and divide by the number of companies and then divide by the divisor.
Though the Dow is widely viewed as the worlds most popular stock market index, the Dow isn’t without its critics. There tend to be two points of contention for using the Dow as a barometer of the US stock market. First, the Dow is comprised of thirty large cap stocks. Critics argue that this is hardly representative of the broader US economy. Second, the Dow is a price weighted index as opposed to a capitalization weighted index. The weakness in this is that a high price stock can have a disproportionate impact on the overall value on the Dow. However, proponents of the Dow argue that in the end, the Dow has a high correlation to the broader and capitalization weighted indices such as the S&P 500 and New York Stock Exchange Index and therefore conclude that these concerns are negligible.