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  • Hi! And welcome to The Motley Fool's Bottom Line series!

  • In this video, we're going to take a closer look at what the Dow Jones Industrial Average is,

  • why people care about it so much, and what some of its limitations are.

  • The Dow Jones Industrial Average is often referred to as the Dow Jones, or simply as the Dow.

  • It's one of the most well-known U.S. stock indices.

  • It was created by Charles Dow in 1896, and is a price-weighted average of the stocks

  • of 30 large American publicly traded companies.

  • It's often used to gauge the market's performance from day to day.

  • What exactly is a price-weighted index?

  • In a nutshell, a price-weighted index means that higher-priced stocks have more influence

  • over the index's performance than lower-priced ones.

  • Consider a fictional index made up of just three stocks, with share prices of $10, $30, and $60.

  • Since the highest-priced stock makes up 60% of the total combined value of the three,

  • a 10% gain in that stock's price would raise the index by 6%.

  • In contrast, a 10% gain in the lowest-priced stock would only result in a 1% rise in the index.

  • In the case of the Dow, the prices of all 30 stocks in the index are added together,

  • then divided by the Dow divisor, which changes over time due to stock splits and other events.

  • The divisor is much less than one, which is why the value of the index is greater than

  • the sum of the stock prices.

  • Here's a current list of the Dow stocks, also called the Dow 30.

  • Many of these companies are household names, but investors should know that the companies

  • in the Dow 30 change frequently.

  • The Dow is still used as a gauge for the market in part because the index has been around

  • for more than 130 years.

  • This long performance history allows investors to evaluate how the market is performing now

  • compared to how it's performed in past decades.

  • Additionally, the companies in the Dow come from a variety of industries in the U.S.,

  • which allows the index to provide a snapshot of how U.S. companies are performing.

  • While the Dow has a long history of helping investors gauge the market's performance,

  • the index does have its limitations.

  • Most obviously, the Dow Jones only includes 30 stocks.

  • There are more than 5,300 common stocks that trade on the New York Stock Exchange and NASDAQ,

  • so the Dow's performance may not be the best indicator of how the overall market is doing.

  • Also, the price-weighting means that some of the Dow components have much more influence

  • on the index than others.

  • For example, as of this writing, Apple's stock trades for about $246 per share, while Coca-Cola

  • trades for just $53.

  • Therefore, a move in Apple's share price would have more than 4X the effect of a similar

  • move percentage-wise in Coca-Cola.

  • For these reasons, the broader and market-cap-weighted S&P 500 is widely accepted as the better indicator

  • of how stocks of large U.S. corporations are performing.

  • The bottom line is that the Dow Jones Industrial Average is still a useful tool for investors

  • who want to keep track of how some U.S. companies are performing, but it's probably not the

  • best gauge to determine how the broader stock market is doing.

  • Thanks for watching this video!

  • Do you think the Dow Jones is still a useful gauge for the overall market?

  • Let us know in the comments below.

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  • It helps us reach more people, which allows us to make more awesome content.

Hi! And welcome to The Motley Fool's Bottom Line series!

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