The Dow Jones Industrial Average: 

Is it a Fair Index of  Industry and Commerce?


By Bernard Levy


    The Dow Jones Industrial Average needs immediate revision.  Why?  It’s no longer a reasonable indicator of Wall Street activity.  Wall Street lives, breathes and becomes healthy and ill on its daily movement, and its current composition is sorely lacking.


    First published in May, 1896, only General Electric remains from the original index.  From my reading of history, the DJIA intended to represent the business pulse of our country.  The first list included all of the industrial companies listed on the New York Stock Exchange.  Food, sugar, tobacco, utilities, chemicals, rubber, coal, iron and manufacturing made the first list.  Originally 12 companies, the list was expanded to 30 in 1928.


    There has been continuing criticism of the Index due to its price-weighted average.  This column was drafted prior to discovering The Dow Jones Industrial Average:  The Impact of Fixing Its Flaws by John B. Shoven, Stanford University and NBER, and Clemens Sialm, Stanford University, published June 29, 2000 as part of The Finance Program of The Stanford Institute for Economic Policy Research.  The paper discusses at length the authors’ conclusion that “The DJIA Has Three Major Flaws,” the first of which was that “Each company in the index is weighted by the price of its stock.”  I realized this flaw before I read the article.  This price-weighted average gives indexed higher-priced stocks wrongfully more clout than lower-priced ones. 


    For instance, during the trading hours of May 30, 2006, the DJIA lost $184.18.  However, the day’s losses of the 30 listed stocks totaled $23.01; all of the listed stocks posted losses.  For an investor who purchased one share of each of the 30 stocks, his or her loss would have only totaled $23.01.  However, to the world, it represented $184.18 total loss.  This doesn’t make much sense, does it?


    Messrs Shoven and Sialm, after giving due credit to others who contributed to their studious work, concluded there were two other major flaws in the index, namely the stocks, “are chosen more or less arbitrarily by the Dow Jones & Co. to represent different industries, but they are not chosen according to fixed or well-defined rules,” and “the DJIA is not a total return index because it excludes dividend distributions.”


    Having covered the first flaw, we now tackle the second flaw:  What then, would be a representative index , in this age of information technology and our preoccupation with drug manufacturers, oil and energy?  (We’ll leave the third flaw for others to consider.)


    Short-term investors, brokerages and Wall Street analysts and stock seers live on short-term swings and volatility to earn their keep and need an up-to-date number one index.  


    The critical questions to be answered in listing relevant stocks are:  What businesses do we rely upon to fuel our economy, and how many categories should be represented on the index?


    According to many economic prognosticators and gurus, our economy’s foundations are housing, information technology and services, consumers, health and related industries, oil and energy and defense.  These, at least, should be reasonably represented; are they?


    The first group, housing, is not included, although it could be tangentially represented by Home Depot.  I’ve placed telecom services – AT&T and Verizon, diversified computer systems – IBM and Hewlett Packard, semiconductor – Intel, and application software – Microsoft, into the second group.  I’ve lumped several categories into the all- encompassing consumer products and services, namely Altria – tobacco and foods, Coca-Cola – beverages, MacDonald’s – restaurants, Proctor and Gamble – consumer goods, Wal-Mart Stores – discount/variety stores, and Walt Disney Co. – entertainment.  My fourth category, health and drugs, only has manufacturers represented, Johnson and Johnson, Merck and Pfizer.  Exxon/Mobil solely represents oil and energy.


    My final category, defense, has Boeing Co. singularly designated as aerospace/defense, although portions of the four conglomerates listed --  3M Co., General Electric, Honeywell International and United Technologies -- should be included in this category.  Others listed may also be considered.


    The above 22 of the 30 stocks represented leave one company representing aluminum, ALCOA (none representing steel); one representing insurance, AIG; one representing chemicals, E.I. duPont; one representing auto manufacturing, General Motors; three representing credit services and money center banks, American Express, Citigroup, and JP Morgan; and one representing farm and construction equipment, Caterpillar.


    What’s missing?  -- Agriculture, steel, possibly another non-ferrous metal company, housing, airlines and specific health-care providers.  Are there any categories that should have additional information on the list?  Yes:  energy, information technology, aerospace/ defense, semiconductors, entertainment, restaurants and perhaps autos.


    Who we are, business-wise, as a nation continually changes.  Airlines, as we know, are currently “in the toilet,” but they are an integral part of our transportation system.  American vehicle manufacturing is in serious difficulty.  Residential and commercial construction has been a major component of our apparent resurging economy.  Wal-Mart, representing all retailers, is unacceptable; at least Sears or Federated should be included.  What about Apple and a major health provider?


    It’s easy to criticize in this age of systemic, epidemic misrepresentation in business and government, but the DJIA is out of touch with market reality.  Investors should be given a relevant index to assess how our economy is viewed through the eyes of the Street.


Business is a combination of war and sport.

André Maurois