When people say, “The Dow”, they are referring to one of the gauges of how the stock market is doing:  the Dow Jones Industrial Average – DJIA or “Dow”, for short.

Each of these companies has a different product-sales focus; that is not a coincidence.  In the estimation of the people who calculate the Dow Jones Index, each serves as a top-tier representative of similar companies.  

In that sense, each of the 30 Dow stocks is supposed to represent that business area; the Dow is intended to represent the thirty biggest and thus most important business areas in America.

The companies that make up the Dow has changed over the years, for two reasons:  new industries appear (e.g., Intel and the microprocessor industry), and over time, companies gain and lose competitive leadership, as their sales wax and wane, and as technological improvements and innovations in the particular type of products  evolve.  The competitive market never stands still, and the Dow Index must be regularly modified to keep it relevant.

Why these stocks? 

Compare the companies in the current Index (above), with this list from the very first Dow Index, in 1896:  

The American Cotton Oil Company

Distilling & Cattle Feeding Co.

North American Company

The American Sugar Refining Company

General Electric Company

Tennessee Coal, Iron and Railroad 

Company

American Tobacco Company

The Laclede Gas Company

The United States Leather Company

Chicago Gas Light and Coke Company

National Lead Company

United States Rubber Company

The S&P 500

The S&P 500 Index is composed of the stock prices of the 500 largest companies (in terms of capitalization).  Unlike the Dow, changes to the stock prices of the more valuable companies affect the S&P 500 index more than stock price changes of smaller companies.

The S&P 500’s five hundred companies represent about 80% of American equity market; i.e., the S&P 500 includes about 80% of all stocks bought and sold by investors in any given time period.

Which is better?

Eighty percent is an overwhelming part of the American economy.  It is hard to argue with those numbers when it comes to being representative of the country’s economic status.

But those 500 companies must purchase their “raw materials” – the stuff they use to build their products – from other companies, many of which are smaller companies not included on the S&P 500.  

The welfare of those smaller companies rests on their ability to sell to that 80% of America’s buying power.  If the 80% are doing well, then the companies not on listed on the S&P 500 will generally be doing well, too.  

If the 80% suffers an economic downturn, rest assured that the smaller companies who depend on that 80% – via direct sales or indirect sales to other small companies – will experience declining sales, and will be suffering as well.

A Clear Answer

The graphs show the Dow and S&P Index values for the past year.  Investors – whether experienced or simply contributing to their 401k or IRA – will note that the S&P 500 Index matches very closely with what has been happening to their own investments.

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