Is The Dow A Good Measure of Stock Market Success?

Like oxygen, reports on the daily doings of the Dow Jones Industrial Average are everywhere. It’s the fastest way to check Wall Street’s pulse. It’s the one benchmark most likely to be quoted in the morning paper and the nightly news.

There are 30 companies which comprise the DJIA, but not the same companies all the time. New companies are added to the list from time to time, which means old companies are removed. And yet, DJIA movements up or down continue to be reported as if nothing has happened.

But that’s not the case. Each and every time Dow membership changes it makes sense to wonder if we are still comparing apples with apples.

Dow history

Started in 1896 with 12 stocks, the DJIA has risen from a first-year close of 40.45 to 12,650.36 as of December 31, 2007. Over a period of 111 years, that’s an average annual increase of 5.31 and a fabulous argument for the joys of compound interest.

But within that general average are a series of ups and downs. The DJIA hit 41.22 in 1932, essentially back where it began in 1896. The benchmark 300 recorded at the end of 1928 was not seen again until 26 years later when the Dow closed for the year at 404 in 1954. The yearly close didn’t top 500 until 1958 and it wasn’t until 1972 that the year-end average finally reached 1000.

Between 1896 and 1981 the Dow grew by an annual average of 3.68%, but between 1982 and 1999 the measure increased at year-end from 1046 to 11497, an average growth of 15.14%.

The catch, of course, is that while the percentages and numbers above are accurate, what they measure has shifted over time.

Dow vs the Olympics

As it happens, the modern Olympics also began in 1896. Thomas Burke of the U.S. won the 100-meter race in 12 seconds flat. In the 2008 Olympic races held in China, Usain Bolt of Jamaica covered the same distance in 9.69 seconds.

It’s possible to compare the efforts of Burke and Bolt because there’s a common measure: 100 meters is 100 meters. We know with total assurance that Bolt is astonishingly faster than Burke.

Alas, the Dow averages from 100 years ago, 20 years ago, and even five years ago track stocks that differ from the ones we watch today, thus comparing results with one period or another requires a whole bunch of asterisks and caveats.

Consistent measure

To faithfully track stock movements from 1896 or within any period we need a consistent measure. The catch is that no stock from 1896 is found on today’s list. One can only guess how the average would look at this time if the DJIA still accounted for American Cotton Oil, Distilling & Cattle Feeding, and U.S. Leather.

And that, of course, is the core point. Companies come and go, investing preferences evolve, and if we are to track marketplace trends then we should not ignore either the great successes or those firms which have become less favored.

Where are they now?

For instance, whatever happened to such DJIA stalwarts as U.S. Cordage (added in 1896), Standard Rope & Twine (1896), Federal Steel (1899), Central Leather (1912), Studebaker (1916), Corn Products (1920), Woolworth (1924), Paramount Famous Lasky (1925), Remington Typewriter (1925), Nash Motors (1928), Postum (1928), Victor Talking Machine (1928), and Hudson Motors (1930)? If we are to fully reflect the path of American commerce, then surely we must account for the direction, destiny, and descendants of these firms. (For a look at the companies which have composed the DJIA over the years, see the Dow Jones Industrial Average History.)

In recent years such new-economy giants as Intel, Microsoft, and Home Depot were added to the list, while Sears, Goodyear, Union Carbide, and General Electric were dropped. The new firms are surely significant, but how many people no longer shop at Sears or reject tires from Goodyear? Did these firms suddenly disappear from the pantheon of corporate America?

On September 22, 2008, Kraft Foods Inc. (KFT) replaced American International Group Inc. (AIG). Where would the DJIA be if AIG had remained on the list? AIG shares were at $2.33 on October 10, 2008 — down from 52-week high of $69.91.

To have a consistent set of benchmarks we need a consistent DJIA so why not evolve a series of DJIAs? In the same way that Super Bowl XXXI inevitably follows Super Bowl XXX, why not acknowledge that the DJIA of the moment is not measuring the same body of information or companies as the DJIA from 2007, 1995, 1930, or 1900? All good years — but all different.

Dow 2.0

And so a modest proposal. Let us anoint today’s DJIA as “DJIA-1.0” When next we add or subtract company members because they merge, fail or somehow become less interesting, we can move on to “DJIA-2.0” Older DJIAs with different corporate members can be named DJIA-X1 or X2 — with X1 being the most recent before the advent of the DJIA-1.0. To have a clear and consistent accounting of what it is that we’re measuring, we can then post the averages for each index each day and easily compare one period with another.

Unless, of course, we’re against clarity and consistent measures.

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Published originally by Realty Times, posted with permission, and updated. Photo by Vandan Patel on Unsplash