FOOL'S SCHOOL DAILY Q&A
How to Calculate the Dow

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By Selena Maranjian (TMF Selena)
May 9, 2002

Q. How is the Dow Jones Industrial Average calculated?

A. The Dow is essentially the average price of its 30 component stocks. This may seem strange, though, with the Dow recently around 10,000 and none of the 30 stocks trading anywhere near $10,000 per share.

On average, though, the shares really would trade in the neighborhood of $10,000 -- if they had never been split, issued dividends, or undergone major changes such as spin-offs or mergers during the time they were listed in the index.

For example, consider a share of Microsoft. If you bought one share of the company when it came public in 1986, it would have been worth less than $100 at the time. But, as of the time of this writing, the stock has split 8 times and that single share has become 144 shares, each worth about $55. Total it up, and that single initial share has grown to be worth roughly... $8,000.

Today, though, most stocks don't trade at such lofty levels -- thanks to events such as stock splits. To get from current stock price levels to the larger index number, a number called the "divisor" is used. The original divisor -- back in 1896, when the Dow was created -- was just the number of stocks in the index (12). However, to account for stock splits, mergers, and such, the divisor has to be adjusted frequently.

The current divisor is 0.14452124. If General Electric falls four points, for example, the DJIA will drop by 28 points (4 divided by 0.14452124 equals 27.68). The overall average is calculated by adding up the current stock prices of the 30 stocks, and then dividing by the divisor.

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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.