Main Stock Market Indexes 

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Main Stock Market Indexes

Dow Jones Industrial Average

The Dow Jones Industrial Average (DJIA) is the oldest and most widely quoted measure of the stock market. The DJIA is composed of the stock prices of 30 large blue-chip companies. The closing stock prices of each of the 30 stocks are added and then divided by an adjusted divisor. This divisor is a very small number (e.g., 0.123051408 as of May 11, 2007), which makes the DJIA a greater number than the average of the stock prices. When the DJIA was first introduced, it was calculated using a simple average of the number of stocks in the calculation. However, because of stock splits and the addition of new stocks to replace stocks that were dropped, an adjusted divisor was used to keep the average from changing for stock splits and the addition of new stocks. This adjusted divisor explains why the DJIA can be a large number such as 10,800 with the addition of only 30 share prices of the companies in the average.

Given the small number of companies in the DJIA, care has been taken over the years to make sure that these companies are broadly representative of the market. Thus, in 1997, four companies [Bethlehem Steel, Texaco, Westinghouse (now Viacom), and Woolworths (now Venator Group)] were dropped and were replaced by Hewlett-Packard, Johnson & Johnson, Citigroup, and Wal-Mart. Later changes included the addition of Microsoft Corporation and Intel Corporation.

Much criticism surrounds the DJIA. First, the stocks are not equally weighted; consequently, an increase in a higher-priced stock has a greater impact on the DJIA than an increase in a lower-priced stock. Second, with a sample of only 30 large blue-chip stocks, the DJIA is hardly a representative measure of the market.

Yet the DJIA still can be of use to investors. First, by looking at a chart of the DJIA over a period of time, investors can see the ups and downs of the market, which can help you to decide when to buy and sell stocks. Second, the DJIA can be used as a yardstick for comparing how your blue-chip stocks and blue-chip mutual funds have performed in comparison with the DJIA for the same period of time. However, because the DJIA is composed of only 30 stocks, you also should look at more broad-based measures of the market. Table 6–1 presents a comparison of the DJIA, the S&P 500 Index, and the Dogs of the Dow for the past 16 years.

The Dogs of the Dow is an offshoot of the DJIA. It involves a strategy of investing in the 10 highest dividend-yielding stocks in the DJIA at the beginning of the year and then replacing the stocks with the 10 highest-yielding stocks the next year.

Other Dow Jones averages are the Dow Jones Transportation Average (DJTA), which is composed of the stocks of 20 major transportation companies, the Dow Jones Utility Average (DJUA), which consists of 15 major utility stocks, and the Dow Jones Composite Average, which combines the three Dow Jones averages and all their stocks.

Standard & Poor’s 500 Index

Standard & Poor’s 500 Index (S&P 500) consists of 500 stocks listed on the New York Stock Exchange and the Nasdaq. The 500 companies included in the S&P 500 Index also can be broken down into the following indexes:
* S&P Industrial Index, which consists of 400 industrial stocks
* S&P Transportation Index, which consists of 20 transportation companies
* S&P Utilities Index, which consists of 40 utilities companies
* S&P Financial Index, which consists of 40 financial companies

Table 6-1
Performance of the Market Indexes

Performance of the Market Indexes

The most often cited of the S&P indexes is the S&P 500 Index. The S&P 500 is a market-value-weighted index that is computed by calculating the total market capitalization (value) of the 500 companies in the index, dividing that by the total market capitalization of the 500 companies in the base year, and then multiplying the number by 10. The percentage increase or decrease in the total market value from one day to the next represents the change in the index.

With 500 stocks, the S&P 500 Index is more representative of the market than the DJIA with only 30 stocks. The S&P 500 Index occasionally adds and drops stocks to maintain a broad representation of the economy. The S&P 500 Index is an important measure of the performance of larger stocks in the market, which is further confirmed by the growing popularity of S&P 500–indexed mutual funds (mutual funds that hold portfolios of stocks designed to match the performance of the S&P 500 Index). These mutual funds outperformed most of the actively managed funds in 1998 primarily because many actively managed mutual funds invested in value stocks and small-capitalization stocks, which all underperformed the 50 large growth stocks in the S&P 500 Index. From 1995 to 1999, both the DJIA and S&P 500 Index more than doubled, only to decrease by about half in the bear market of 2000–2002. The broader market of small-capitalization stocks lagged and did not participate in the four-year rally from 1995 to 1999. Small-cap stocks outperformed large-cap stocks in the five-year period from July 2001 to July 2006.

New York Stock Exchange Composite Index

The New York Stock Exchange Composite Index is a more broad-based measure than the S&P 500 Index because it includes all the stocks traded on the New York Stock Exchange (NYSE). It is a marketvalue- weighted index and, like the S&P 500, relates to a base period, December 31, 1965. On that date, the NYSE Composite Index was 50. In addition to the NYSE Composite Index, the NYSE also has indexes for industrials, utilities, transportation, and financial stocks.

Nasdaq Composite Index

The Nasdaq Composite Index is a measure of all the stocks traded on the National Association of Securities Dealers Automated Quotations (Nasdaq) System. The Nasdaq Index is more volatile than the DJIA and the S&P 500 because companies traded on the over-the-counter (OTC) market are smaller and more speculative than the larger companies that trade on the NYSE. Thus an increase in the Nasdaq Composite Index can be interpreted as investor enthusiasm for small stocks.

Other Indexes

The American Stock Exchange (AMEX) Index is value-weighted and includes all stocks listed on that exchange.

The Wilshire 5000 is the broadest index and includes all companies listed on the NYSE and the AMEX, as well as many of the larger stocks traded on the OTC market.

The Value Line Composite Index differs from the other indexes in that it is calculated with a geometric averaging method using 1,700 stocks listed on the NYSE, AMEX, and OTC markets.

The Russell 3000 Index is a broad-market index that offers investors access to 98 percent of the U.S. market. The largest 1,000 stocks in the Russell 3000 Index make up the Russell 1000 Index, and the smallest 2,000 stocks in the Russell 3000 make up the Russell 2000 Index (a measure of the performance of small-cap stocks).

The EAFE Index is the benchmark for foreign stocks and foreign stock mutual funds. The EAFE is the Morgan Stanley Capital International Europe, Australasia, Far East Index, which includes 1,026 stocks from 20 countries.

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