Last week’s hoopla makes this a perfect time for the iconoclasts among us to ask why we care so much about the Dow, and whether it’s time to put the old average out to pasture. After all, the Dow isn’t a very accurate measure of the stock market. it’s based on only 30 blue-chip stocks. Giant General Electric counts exactly the same as woeful Woolworth. There are no Nasdaq stocks, no foreign stocks. A big move in one stock can distort the whole index.
The most telling sign that the Dow ain’t all that good comes from market pros. When they have money at stake, they rate their investment performance against the S&P 500. There are hundreds of billions of dollars of investors’ money tied to the S&P, but little or nothing tied to the Dow. In fact, if the Dow didn’t already exist, no one would bother to invent it. Back 100 years, in the BC era -Before Calculators-Charles Dow hit on the idea of adding up the prices of 12 well-known companies and dividing them by 12. The average, with its 30 stocks, is still computed the way Charles Dow did. Except that instead of dividing by 30, you divide by 0.33839549. (Don’t ask where that number comes from; believe me, you don’t want to know.) A dollar move in Coca-Cola, which adds or subtracts $2.5 billion in stock-market value, moves the Dow the same 2.96 points as a dollar move in Bethlehem Steel, which makes only a $113 million difference. It’s not very sensible, is it?
The S&P, by contrast, is a purist’s delight. And very complicated to calculate. It started out in 1923 with 233 stocks and grew to 500 in 1957. Each company is weighted by its stock-market value. GE, with about $140 billion in stock-market value, counts 100 times as much as Bethlehem Steel, with about $1.4 billion. The Dow and S&P track closely for short periods, but not for the long haul. Last year, for instance, the Dow rose 33.3 percent, the S&P 34.2. But for the 10 years, the Dow was up 230.9 percent, the S&P up only 191.5 percent. The S&P is far the more realistic measure.
Why is the Dow still with us? There’s a lot to be said for having been around for 100 years. Inertia and tradition are powerful forces. They help explain why people keep money in 2 percent passbook accounts when they could get 5 percent in a money-market mutual fund. And there’s a certain comfort in using the same average to measure the stock market year in and year out.
The Dow-S&P competition triggers almost as much trash talking as a pro basketball game. “It’s a convenient, quick and easy indicator of what stocks are doing,” boasts Dow Jones spokesman Lawrence Budgar, explaining the Dow’s continuing hold on the public. When I told John Prestbo, the Dow’s guardian, that I had read the history of the S&P index, he quipped, “And you’re still awake?” S&P sees things somewhat differently. “They’ve been fortunate,” says S&P senior vice president Jim Branscome, because the Dow has tracked the S&P closely for short periods. But he predicts that won’t last. And, “their next centennial isn’t going to be anywhere as happy.” But the Dow has thrived despite its shortcomings. It could improve itself by including more stocks and letting the likes of GE and Coke count more than Union Carbide and Bethlehem Steel. But that would destroy the Dow’s simplicity and continuity. And those are its major selling points.
So, imperfect indicator that it is, the Dow will rock on for the foreseeable future. But let’s not make more of the average than it is. Any more gushing and retrospection about Charles Dow and the past 100 years, and I might begin to think Henry Ford wasn’t all wrong when he said, “History is more or less bunk.”
