The Dow Jones Industrial Average turned 120 years old this year. In the Atlantic’s piece noting the occasion, Bourree Lam discusses the index’s history and drawbacks—particularly the fact that it only measures the winners, the companies on the cutting edge of the American economy.
Lam argues that the Dow is misrepresentative of the stock market, to say nothing of the economy as a whole. She quotes Richard Sylla, a professor at NYU’s Stern School of Business, as saying that “the Dow is hardly a history of the U.S. economy. It is an index— unweighted—of the stock prices of a small number of America’s largest corporations selected to represent the leading firms at particular times in our economic history.” Since “firms are removed from the index when thought to be less representative of corporate leaders… this tends to make the economy to [sic] look better than it actually is.” This is problematic, Lam claims, because “there’s hardly a news story about the American stock market that doesn’t mention the index’s industrial average.” So, by following the DJIA, investors are getting an inaccurate picture of the overall market and the broader economy. But how much of a drawback really is this?
By focusing on per-share price, the DJIA certainly doesn’t provide a comprehensive assessment of the companies in question. However, while per-share price is not the only data point that matters in assessing investment decisions, it ought not to be dismissed out of hand. With a few exceptions (yes, Alcoa should have been booted earlier), the DJIA per share price can tell you something about what companies have been particularly successful in creating value for their shareholders.
Another point that Lam and other critics have is the Dow’s focus on only 30 companies, as opposed to a much broader index like the S&P 500. Here though, it’s important to consider human nature. Of course we have technology today that makes a 30 company index seem archaic, but that doesn’t change the fact that it’s useful to have a more focused slice of the market as well as broader measures. You could think of the Dow as a heuristic for the market—it’s a shortcut, a quick go-to measurement that you can then compare to other, broader indices. Just because the DJIA doesn’t tell you everything about the market or the economy doesn’t mean it doesn’t tell you something.
After all, it can’t hurt to know who the “winners” are.