This article is part of our Better Investor series, in which The Motley Fool goes back to basics to help you improve your returns and be more successful with your investing.

Millions of ordinary people know more about the Dow Jones Industrial Average (INDEX: ^DJI) than any other market measure. But as a way of gauging the health of the U.S. stock market, the Dow has huge flaws that make it almost a useless measure.

An apple a day
Earlier this week, Bespoke Investment Group pondered the possibility of adding Apple (NAS: AAPL) to the Dow. It's easy to understand why the move would have broad-based appeal, as Apple has flirted with the status of the nation's largest stock by market cap.

There's little doubt that Apple deserves recognition as one of the most important U.S. companies, given its dominant influence on technology in the last decade. But as Bespoke pointed out, the move would have a huge effect on the Dow. Because Apple's share price is more than $400, the stock would have a mammoth 22% weighting in the average. Therefore, Bespoke concluded, unless the iDevice giant were to agree to a share split -- something it hasn't done since 2005 -- it wouldn't be feasible to include the stock among the Dow 30.

Simple gauge or outdated relic?
On its face, the Dow seems like a simple yet efficient way to look at the market's overall health. Choosing 30 stocks from a variety of important sectors of the economy, the Dow Industrials now go well beyond traditional industrial stocks to include financials, health care, retail, and even fast food. And the ease of adding up all of the share prices of the Dow's components and then dividing by a common factor to come up with the average's value couldn't be easier.

But the Dow's simplicity also creates some disparities between it and other common market measures like the S&P 500. The biggest is the fact that companies with the highest share prices have the most weight in the index even if their overall size doesn't match up with its share-price ranking. For instance, right now, IBM (NYS: IBM) has by far the largest weight in the Dow, making up more than 11% of its value. Even when you add up the nine components with the smallest weights in the Dow, they still have a smaller combined effect on the average than IBM does -- even though those nine stocks include Microsoft (NAS: MSFT) , which has a larger market cap and greater net income than IBM.

Other disparities make themselves felt within sectors. ExxonMobil (NYS: XOM) is far larger than Chevron (NYS: CVX) by every financial measure, including revenue, profit, and market cap. Yet Chevron trades at about $100 per share while Exxon is stuck at $75, so Chevron has a bigger effect on the Dow's overall moves. The same holds true for the larger, lower-priced Pfizer (NYS: PFE) versus the smaller Merck (NYS: MRK) and its more expensive shares.

All the wrong moves
In addition, the Dow has made some bad missteps in its decisions to make changes to its lineup of companies. It admitted Microsoft just as the tech bubble was nearing its top, and added AIG during its heyday in 2004 -- only a few short years before its near-total collapse. Its timing was even worse when it added Bank of America in 2008, just before the worst of the financial crisis struck.

Of course, not every move the Dow has made has been bad. And even in its bad calls, the Dow is hardly alone. The S&P 500 has also made some big miscues in its timing of adding and deleting companies from the benchmark.

But combined with the more mathematical problems associated with the average, the Dow is a dubious measure of the health of the overall stock market. Despite the Dow's historical significance, you'll do better tracking individually the stocks that make up the average -- as well as others that can fill your portfolio to give it the diversification you need.

Several Dow components pay big dividends right now. To see them and other attractive dividend stocks, be sure to check out the Fool's free special report, "13 High-Yielding Stocks to Buy Today."

Stay tuned throughout our Better Investor series and get the advice you need to succeed with your investments. Click back to the series intro for links to the entire series.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.

At the time this article was published Fool contributor Dan Caplinger understands that 50-point drops in the S&P don't sound as dramatic as 500-point drops in the Dow. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Bank of America, Microsoft, Apple, IBM, and AIG. Motley Fool newsletter services have recommended buying shares of Pfizer, Chevron, Microsoft, and Apple, as well as creating bull call spread positions in Microsoft and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't ignore you.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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ivyteainn

What propaganda. When there is a bull, they say listen to the DOW; when there is a bear market, they tell you to ignore it. What liars. The stock market is just ponzi scheme to get you to invest in corporations. They get your money with promises of fanatastic futures that don't pan out. Many people have lost fortunes in the market.

September 23 2011 at 2:41 PM Report abuse rate up rate down Reply
street163

Dear folks, stop listening to the morons on TV. If you are invested in the stock market or are planning to be, my advice is buy high yielding blue chips, don't speculate. There are industrial s and pharmaceuticals that are paying 4 to 7 percent. When the market tanks these stocks lose a few cents.Get a discount brokerage account stay away from portfolio managers buy the good stuff get your quarterly dividends. Good luck The U.S. economy is stronger than the media wants you to know,they survive off of panic and fear, we are Americans think for yourselves and stay positive.

September 22 2011 at 8:22 PM Report abuse rate up rate down Reply
Michyle

The Dow is affected by to many "Nervous Nellies" they sell or buy according to whatever the news says.
Greece is going to tank,,SELL!
Apple is expanding one of its Devisions,, BUY!!
The next thing you know the news is telling something totally different, and you reverse your options.
Personally I monitor my HMO daily but I put more faith in the weekly prices.
The Dow is just to slow for todays economic washing machine.

September 22 2011 at 8:59 AM Report abuse rate up rate down Reply