The Dow Jones Industrial Average is one of the most sought-after stock market indices. It provides investors with a snapshot into how certain industries are performing, enabling you to formulate short or long-term investment strategies accordingly.

Charles Dow, founder of the Wall Street Journal, created the Dow Index in 1896 with only 12 companies listed at that time.

What is the Dow Jones Industrial Average?

The Dow Jones Industrial Average (DJIA) is one of the world's most closely followed indices. It tracks 30 blue-chip stocks, mostly industrial companies and serves as both a leading indicator for US stock market direction as well as an investment research benchmark.

In 1896, Charles Dow and his business partner Edward Jones created the DJIA with the purpose of creating a straightforward average that would reflect stock market activity. At that time, investors were generally unaware of how stocks traded.

This led them to create an average that could serve as a "market thermometer," similar to placing sticks in the sand to determine whether the tide was coming in or out. By selecting only the largest and most stable companies from each of the major industrial sectors, this average was designed to serve as an accurate barometer of how well all markets were performing collectively.

The DJIA is a price-weighted index, meaning that it gives more weight to companies with higher share prices than those with lower ones. However, the index also uses a divisor to offset any structural changes such as stock splits so that its value does not change too drastically over time.

How is the Dow calculated?

The Dow is a widely-followed indicator of stock market activity and one of the most frequently discussed news headlines. If you listen to radio or watch cable news, chances are good that you hear about the Dow and S&P 500 every day.

The Index began as a simple average of the values of its 12 stocks, and it remains price-weighted; that is, bigger changes in higher-priced stocks will have greater influence over its average. Over time, however, the committee overseeing the Index has adjusted their methodology to incorporate changes such as stock splits, dividends, additions or deletions of companies, among other factors.

Calculating the DJIA, its overseers use a divisor (a number that measures how stock price changes affect each stock's impact) to calculate how one point move in each stock will affect the average. This number is updated frequently to adjust for changes to components of the Index or rebalance it so that it accurately reflects market activity.

In 1928, a new method for handling stock splits was devised that adjusted the divisor so that the average after the split equaled the pre-split average. For example, Company A's share price pre-split was $10; Company B's pre-split value is $20; and Company C's post-split value is $15.

This change in the Divisor can present challenges, as it's more likely to give more weight to high-priced stocks than low-priced ones. That is because high-priced stocks tend to offer more dividend opportunities and participate in dividend reinvestment plans, which can cushion portfolio losses temporarily and boost returns later on.

What are the criteria for joining the Dow?

Companies may be removed or added to the Dow Jones Industrial Average at various times for various reasons. One common reason is a company's failure to file necessary filings. Other causes could include violations of its listing agreement with NYSE or lack of an adequate audit committee.

Companies adding to the DJIA typically possess excellent reputations, have sustained growth and appeal to a broad base of investors. Furthermore, it's possible that a company could be added after it implements a stock split.

The DJIA is a price-weighted index, meaning the higher a company's share price, the greater its influence over the index. This differs from other leading indexes such as S&P 500 or NASDAQ which take into account market capitalization when determining a company's weighting.

Therefore, the Dow Jones Indexes are typically decided upon by a committee composed of representatives from S&P Dow Jones Indices and Wall Street Journal editors. Although there are no fixed criteria for inclusion or exclusion, generally speaking the committee takes into account a company's performance over time.

Another key indicator of success for a company is the amount of revenue generated in the United States. Companies with higher percentages of their sales coming from here tend to perform better than those without.

Company inclusion or exclusion can also be affected by other events, such as an acquisition, accounting scandal, or bankruptcy. However, these are far less prevalent than the factors that ultimately determine inclusion or exclusion.

How long does a company stay in the Dow?

The Dow Jones Industrial Average is the standard market benchmark that serves as the primary reference point for most investors. Published by S&P Dow Jones Indices, this index tracks 30 stocks across various industries.

It is a price-weighted index, meaning its value shifts more dramatically when large changes in shares of higher-priced companies occur than if the same move took place among smaller-cap stocks. Furthermore, it uses a divisor which is adjusted periodically for corporate actions like stock splits and dividend payments.

As with all indices, the Dow Jones Industrial Average's number of companies changes over time due to events like corporate actions or mergers that alter its composition.

While some original members, such as General Electric, remain on the list, they are frequently removed for reasons such as financial performance or relevance to the index's purpose. In 2018, GE was removed from the DJIA and replaced by pharmacy giant Walgreens Boots Alliance (WBA).

S&P Global, which operates the Dow Jones Industrial Average and S&P 500 indexes, evaluates companies for inclusion into its index based on several factors including industry performance, financial outlook and management quality. These decisions are made by a committee comprised of representatives from both organizations: S&P Global and The Wall Street Journal.

Additionally, companies must help the index maintain its desired exposure to their sector. Doing so helps guarantee that the index remains as representative of American business as possible. In recent years, technology firms have been added to the mix, while many industrial stocks have been delisted - a trend which parallels America's transition from a manufacturing-based economy to one based on services.

What is the S&P 500?

The S&P 500 is a market-capitalization-weighted index of about 500 stocks maintained by S&P Dow Jones Indices, a joint venture between S&P Global (formerly McGraw Hill Financial), CME Group, and News Corp. This index measures the performance of large-cap stocks and serves as the basis for many index funds and exchange-traded funds.

The stock market can be highly volatile, and investing in the S&P 500 does not guarantee a secure return. Nonetheless, this index has demonstrated an ability to deliver returns that are generally higher than those offered by other assets.

Investors can use it as a benchmarking tool to gauge their portfolio performance against. Furthermore, it offers an indication of how well the economy is doing overall.

In order to be included in the S&P 500 index, a company must meet certain criteria. These include being headquartered in America, having positive as-reported earnings during its most recent quarter and being organized as an entity with common shares.

Each company is then assigned a percentage weight in the index, determined by adding together its market cap and dividing it by the total market cap of all companies included in the S&P 500. The larger a company's market cap, the bigger its allocation to the index will be.

The S&P 500 index comprises many different types of businesses, and changes to its composition often reflect market conditions. For instance, if a company drops out, it could indicate economic slowdown or imminent recession. As such, investors should understand how changes to S&P 500 weighting affect its value overall.