Ever wonder how the Dow Jones Industrial Average is calculated? It's 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 (NASDAQ:MSFT). 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 eight times, and that single share has become 288 shares. Total it up, and that single initial share has grown to be worth more than $7,000.
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. Here's how it works.
If General Electric (NYSE:GE) falls four points, you just divide four by the divisor (which is adjusted frequently, and was 0.13500289 last time I checked). This shows that this drop will decrease the DJIA by 29.63 points (4 divided by 0.13500289 equals 29.63). The overall average is calculated by adding up the current stock prices of the 30 stocks, and then dividing by the divisor.
Besides GE and Microsoft, the Dow includes such blue chips as Intel (NASDAQ:INTC), ExxonMobil (NYSE:XOM), Citigroup (NYSE:C), Johnson & Johnson (NYSE:JNJ), and Wal-Mart (NYSE:WMT). The companies are selected by the editors of The Wall Street Journal.
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