The Dow Jones Industrial Average – An Index with a Cool Factor

Monday, November 23, 2009

99685_swatch_clock_10The Dow Jones Industrial Average (DJIA) gets a bad rap. It has been labeled as passé, flawed, unrepresentative, simplistic and old economy – everything but “cool.” However, following the recent market turmoil and economy dislocations, it now possesses what no other index has: focus and understandability. This is why I believe the DJIA is the index to study in today’s market…

The DJIA includes 30 top US companies. “Industrial” refers basically to all major industries excluding transportation (air, rail, trucking, marine and shipping)  and utilities (primarily electricity). As the US economy expands and companies grow and change, Dow Jones updates the list. The current list reflects well the drivers of today’s US economy. This is why I say it has “focus.”

Indexes are used both to track performance and to show composite fundamental information. The DJIA is a price-weighted index, an average calculation that made more sense when the index was created. However, we can easily change that weighting. I prefer equal weighting because each of the DJIA companies is large and a leader in a key industry. By doing so, we can easily examine and compare both individual company and DJIA composite characteristics. This is why I say it has “understandability.”

There is a final, important reason for concentrating on the DJIA: Investors should be looking at and understanding individual stocks in this market. (See “Missing the Trees for the Forest – Look at Individual Stocks.”) The pervasive use of funds has altered the investors’ perspective. Looking only at portfolios means an investor concentrates on “big picture” issues: economic, political and world. Instead, the focus should be on distinct companies. The DJIA’s short list of 30 is just the place to start.

For example, we all read about the cycle of unemployment + financial difficulties = reduced consumer spending and retail sales. That’s all well and good for the economist to ponder, but what about Wal-Mart? What is Wal-Mart’s management up to, and what are they doing in this environment? In good times, most companies do fine. But in a recession, strong companies can shine and even expand at the expense of weak competitors. Then, when conditions improve, they can produce outstanding results. If Wal-Mart is in that position, it could make a good investment now, in spite of 10.2% unemployment. (*)

So, concentrate on the DJIA and its 30 stocks. Worrying about the economy will only keep an investor out of stocks. But focusing on leading companies and understanding them can result in investing success.

(*) Wal-Mart is an example only and should not be taken as a recommendation.

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John Tobey on Seeking Alpha

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November 2009