When people ask how the market is doing, they usually mean What is happening to the Dow Jones average of 30 industrial stocks - an index that goes back to 1896 and which is far and away the most popular and widely quoted of all stock market performance measures.
Featured prominently in all newspaper stock market summaries and usually the only piece of market information broadcast on the nightly network newscasts, it is an easy and agreed upon way to take the daily investment temperature of the country.
"Because of its wider psychological impact, and because of the popularization of the index in the news media, the Dow Jones industrial average becomes synonymous with the market," said Newton F. Zinder, vice president with E.F. Hutton & Co.
However, at times the Dow Jones average can give a misleading picture of what is happening in the stock market.
One reason is that the industrial index is composed of only 30 stocks - ableit well known, widely held and heavily capitalized blue chips that represent in market value 25 percent of the entire Standard & Poor's 500-stock average.
The 30 industrials are Allied Chemical, Alcoa, American Brands, American Can, American Telephone & Telegraph, Bethlehem Steel, Chrysler, Du Pont, Eastman Kodak, Esmark, Exxon, General Electric, General Foods, General Motors, Goodyear, Inco, International Harvester, International Paper, Johns-Manville, Minnesota Mining & Manufacturing, Owens-Illinois, Procter & Gamble, Sears Roebuck, Standard Oil of California, Texaco, Union Carbide, United Technologies, U.S. Steel, Westinghouse Electric and Woolworth.
If any of the Dow components has a particularly good or bad day, it can affect the entire index.
Consider what happened Tuesday when U.S. Steel Corp. announced that, because of sagging profits, it would cut its quarterly dividend from 55 to 40 cents a share.
The nation's largest steel maker halted trading for the announcement and closed at $28.50, down $3.875 a share for the day. That alone was enough to lower the industrial average by 2.69 points (each one-dollar move in any one of the Dow stocks represents a change of 0.693 points in the index).
As a result, "the market" closed off for the day by 2.52 points. Without the U.S. Steel decline, the Dow industrial average would have been up 0.17 points, closer to what happened in the broad list of New York Stock Exchange-traded companies, where 689 advanced and 676 declined.
The Dow Jones industrial average (there is also a 20-stock transportation index, a 15-stock utility index, and a composite index of all 65 stocks) is price-weighted, meaning that the prices of all 30 stocks in the index are added together and then divided by a common divisor which is revised periodically to reflect stock splits or mergers.
(The current divisor can be found daily below the Dow Jones charts and tables on the second to the last page of the Wall Street Journal, which is published by Dow Jones & Co.)
No attempt is made to weight the average by the size of a company's outstanding stock capitalization, nor does the trading activity in a component of the index on a particular day affect the size of a decline or advance.
The fact that 667,000 shares of U.S. Steel changed hands on Tuesday, making it the most active stock on the Big Board, had no impact on the calculation of the Dow average.
Because of this price-weighting, a 10 percent move in Du Pont, which currently sells at about $107, would move the Dow industrial average by nearly 7.5 points. A 10 percent move by Chrysler, which currently sells at around $13, would move the index by only 0.9 points.
"When there is news impact on one of the high-prices stocks, like Du Pont or Procter & Gamble, it is much more important to the Dow than one of the lower-priced stocks," observed Robert Stovall, director of investment policy for Dean Witter Reynolds Inc.
Stovall also claimed that the Dow contains other distortions, mainly that "it is constructed on and maintains the old bias of heavy industrial representation." The Dow emphasizes "smokestack America" industries like automobiles, oil, chemicals and steel, while excluding any pharmaceutical, data-processing, high-technology or health-care stocks, all popular with investors, said Stovall.
He estimated that if the Dow industrials included Merck, the biggest drug company, IBM, the biggest computer company, and Hewlett Packard, the most important scientific instruments manufacturer, it currently would be calculated at around 1200 instead of 775.
Last year, when the heavy cyclical-industrial stocks were being dumped by institutional investors, the Dow reflected this by plunging 17 percent for the year. The broader NYSE index was down only 9 percent, the S&P 500 was off 11.5 percent, and the Amex index, reflecting smaller-capitalization companies, was up more than 155 percent.
Conversely, the Dow industrial average did much better than the broader market in 1972, peaking at an all-time high of 1051 in the first weeks of 1973, and failing to signal the severe bear market of 1973-74 that soon followed.
Stovall also complained that Bethlehem Steel's $400 million one-time write-off in 1977 and similar net loss for the year would produce a distortion in the Dow index that will last for years to come.
The outsize loss produced a 6 percent decline in pershare profits for the combined Dow industrial stocks in 1977 although corporations as a group registered an average 11 percent profit gain last year.
This overstates the current price-earnings ration of the Dow industrials and will cause misleading comparisons in the years ahead, he said.
There has been no wide-scale revision of the Dow Jones industrial average in many years. (The Dow Jones railroad index, a throwback to the 19th Century, was not replaced by a broader transportation index which includes airplanes and trucks until 1969, and only after numerous complaints from analysts.)
The last change in the makeup of the index was several years ago when Minnesota Mining & Manufacturing was added to the list to replace Anaconda, the copper company which had been gobbled up by Atlantic Richfield.
Peter Frein, chief statistician for Dow Jones, defends the 30-stock index. He says the components "represent a good 'cross-section" and include companies "that have proved themselves over a long period of time." Changes in the Dow are "a fair representation of movements in the market," he says, and calls the index "an accurate barometer."