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Dow Jones

After getting close and even creeping above the mark Tuesday, the Dow Jones Industrial Average closed above 23000 Wednesday on the strength of shares of International Business Machines Corp. (NYSE:IBMC).

IBM reported better-than-expected quarterly results and was the primary driver of the record-breaking close. The S&P 500 Index closed at 2561 up nearly 2 points on the day and the NASDAQ Composite bowed out at 6624 up more than half a point.

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Why It Matters

The Dow Jones Industrial Average (DJIA) is the oldest and most well-known stock market index. It measures daily prices for blue chip stocks of 30 large American companies. In addition to IBM, companies include Apple Inc. (NASDAQ:AAPLC), Microsoft Corp. (NASDAQ:MSFTB), Johnson & Johnson (NYSE:JNJC) and others.

As a price-weighted index, the DJIA is divided by a divisor, a continually adjusted number designed to smooth out the effects of stock splits and dividends. Because of this, the DJIA is only affected by changes in the prices of stocks. This means stocks with a higher share price have a larger impact on the movement of the Dow.

Short History

Charles Dow created the predecessor of the DJIA in 1885. It consisted of two capitalized industrial and 12 capitalized railroad companies. He intended to track U.S. economic strength by observing the companies in his index which he considered to be the backbone of the U.S. economy.

A year later, in 1886, Dow altered his original index to contain 10 railroads and two industrials. In the mid-1890s, recognizing the importance of the industrial sector, Dow altered his index to consist entirely of industrial stocks. Finally, in 1896, the first actual DJIA, containing 12 stocks, appeared in The Wall Street Journal. Of the original companies only the General Electric Company (NYSE:GEC) remains.

Criticism Of The Dow

As respected and powerful as the DJIA is, it certainly has its critics. For one thing the use of a price-weighted index means that a stock with a $100 share price has 5 times the influence of one that sells for $20. (This is a simplification of the math.) Suppose the company with the smaller share price had a market cap 10 or 15 times that of the company with the more expensive share.

One effect of this is that some companies like Berkshire Hathaway (NYSE:BRK-BD) could never be included in the Dow because at $100,000 per share, the company's Class A shares would represent the entire index. The same (in reverse) would apply to stock splits. Because of this “flaw” the divisor used in calculating the DJIA is often modified to account for corporate events and transactions.

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Investing In The Dow

While you can’t buy shares of the DJIA per se, there are indexes including several ETFs that track the price movements of the Dow. And of course, you can always buy shares of the companies included in the DJIA.

Mostly, however, the DJIA continues to serve its original purpose as a market and economic indicator. So long as it contains companies that reflect the major industrial areas of the U.S. economy, the Dow will continue to remain a solid indicator of the business economy of the United States.

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