Learn What The Dow Jones Industrial Average (DJIA) And The S&P 500 Measure
If you listen to the radio, watch the TV news, or have a news feed on your phone, you can’t escape the Dow Jones Industrial Average and the S&P 500. Every radio newscast ends with an update of one or both. Cable news channels stream the numbers in real time. They pop up on your digital device as breaking news bulletins.
Yet, for all that, here’s the extent of what most folks know about the Dow and S&P numbers: Up is good, down is bad. And that’s OK. After all, these measurements are designed to provide a sense of how the stock market is performing and to track that performance over time.
But if we’re going to use these numbers to make decisions, judge progress, and help assess the overall state of the world, it makes sense to have some understanding of how they are calculated. So, here we go:
The Dow Jones Industrial Average
What is it?
The Dow Jones Industrial Average (DJIA) – A basket of 30 US companies, all highly significant to the US economy. The DJIA is a price-weighted average of these 30 companies.
How is measured?
The Dow is a scaled average and a scoring system of the sum of the share prices of the 30 American companies that make up the Dow. The Dow number changes every day because of the daily price movements of these 30 equities. This scaled average is technically a derivative of price, and not based on market capitalization (more on that in our discussion of the S&P 500). At its core, it is an expression of dollars.
But not only does the Dow measure dollars, it also measures size. Dollars because it looks to each company’s share price, and size because it looks to the sum of the component’s stock prices. So, each Dow point represents a scoring system that first looks at price. And because the price of a stock impacts a company’s total size (market cap), the Dow’s scoring system also measures size, which is ultimately a measured in dollar value.
The formula for the Dow is based on adding all of the 30 share prices together, and then dividing that sum by a moving divisor that accounts for stock splits, dividends and spinoffs (a type of stock divestiture). Each resulting point level for the Dow is essentially an odometer reading or price tag that represents a dollar value for the basket of the 30 stocks.
So, a point on the Dow is a representation of dollars and cents. But exactly how much is one Dow point worth? I’m glad you asked. It’s a bit of a moving target. Here’s a good approximation. Divide 1 by the current Dow figure and multiply that by the total Dow market capitalization. Our formula looks like this:
1/Dow x Total Dow Market Cap
If we plug in some recent numbers, we get:
1/23,000 x $6.2 trillion = $270 million
Here, one Dow point is equal to approximately a quarter of a billion dollars of dollar value or company size.
Because the market capitalization of the individual component companies isn’t specifically considered in the Dow calculation, this number is a bit wobbly. Because the Dow is based on its component companies’ share prices – not their market capitalization – stocks that trade at a very high level can have a disproportionate impact on the overall Dow number.
Investment bank Goldman Sachs, for example, has a market cap of about $95 billion and currently trades around $240 a share. Apple has a market cap of $862 billion but trades at “just” around $167 per share. So, if Goldman has a really rough day and losses, say, 10% of its share value, the Dow will feel that pain a bit more sharply than if Apple suffers a similar setback. GE, despite market cap of $173 billion, would have to experience wild movement to seriously impact the Dow, as it trades around $20 a share.
The S&P 500
What is it?
Conceptually, the S&P 500 is an index made up of 500 stocks selected by economists to represent the performance of the top large-cap companies in America. Like the DJIA the S&P 500 is also a scoring system. However, instead of using price as a primary measure, the S&P 500 uses company size to determine what components have the greatest impact aka “cap weighted.”
How is measured?
The S&P 500 is a scoring system that measures size (market cap) in dollars. Each S&P point is a measurement of the underlying market capitalization of these 500 US stocks. To measure or calculate the S&P 500, we take the sum of the market capitalization of the 500 component companies and divide them by another floating divisor. This divisor, like that used by the Dow, fluctuates to accommodate for stock splits, special dividends, and spinoffs. Currently, the divisor is somewhere near 9 billion.
At its essence, an S&P point is a representation of a unit of market size or value – meaning a measure of the market capitalization in dollars.
So, what’s an S&P 500 point worth? Let’s do the math. We use the same formula as we did with the Dow, which gives us:
1/S&P 500 Price x Total S&P 500 Market Capitalization
If we plug in some current figures, we get:
1/2560 x $22.5 trillion = $8.9 billion
And there we have it. One S&P 500 point is equal to almost $9 billion worth of company size or dollar value. Because the S&P 500 takes into account market capitalization (unlike the Dow), you won’t be surprised to learn that Apple has a lot of sway in this figure.
Sorry about all the math. But it really was necessary to provide a useful explanation of these two important numbers. I’m a big believer that you should understand every investment you make. Knowing what’s behind the numbers that define the stock market’s current state and history is critical to that understanding.