Each Dow Jones Average Index has divisors which is a number that converts the changes in the prices of the stocks into Index points. A dollar change does not translate into a point change in the index.
The Dow Jones Industrial Average is comprised of 30 stocks and the aggregate daily changes are divided by the divisor to obtain that day’s change. The divisor is shown daily in The Wall Street Journal under the daily change and a similar position in the weekly Barron’s. Right now the divisor is .15198707565833. When you divide a $1 change in a stock’s price by the divisor you get about 6.58 points ($1 ÷ .15199). Another way is to multiply the daily change by 6.58. If you round it to either 6 or 7 you’ll still get a good estimate of the effect of the daily changes.
An example is if United Health goes up by $1 that will affect the index by about 6.58 points ($1 ÷ .15199 = 6.58). A $1 change in Walgreen’s will also affect the index by that same 6.58 points.
The difference in the importance or weight in the index is that a $1 change in United Health (the highest priced stock in the DJIA) is about a .28% change in that company’s value while a $1 change in Walgreens (the lowest priced stock) is a 2.5% change in its value. Another way to look at this is that if both companies were to change by 2%, United Health (2% x $350 = 7) would affect the DJIA by 46 points (7 ÷ .15199) points while Walgreens by 5 points ($40 x 2% = $.80 ÷ .15199). Therefore, United Health has a much greater effect (or weight) than Walgreens on the index. Restated: the higher priced stocks have much greater weight on the index than the lower priced stocks. When Apple split 4 for 1, its $500 price dropped to $125 moving its weight from the top to the lower part of the middle. The divisor also changed at that time to adjust for this.
The divisor changes every time there is a change in a component of the index. Some of these changes are stock splits, mergers, acquisitions, dividends paid with stock (rather than cash), spin offs and even changes in the index components. The purpose of the divisor is to maintain the index on a consistent measure of the market so it can be compared with the past and used to track the future. I could present an illustration how the divisor is calculated, but that would be something like explaining how a hot dog is made, which might be interesting, but who really cares?
This divisor method does not apply to the S&P 500 and Nasdaq indexes which are capitalization (cap) or market value weighted. That means that the changes are based on the aggregate changes in the market value or market cap of its components.
I hope you found this informative and interesting. I also think it is important to understand how this works.
If you have any tax, business or financial issues you want to discuss please do not hesitate to contact me at [email protected].
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