Dow 13,000: What It Means to You

Dow 13,000: What It Means to YouWe're back, baby! On Tuesday, the Dow Jones Industrial Average (^DJI) closed at 13,005. This was the first time the Dow had crossed the 13,000 line since its plummet as the nation sank into the financial crisis.

The Dow reached the 13,000 mark for its first time ever on April 25, 2007 -- just a bit less than five years ago. It kept climbing, all the way up to close at 14,164 on Oct. 9, 2007. But then began its long slump, and on May 19, it dropped back below the 13,000 mark, and has stayed sub-13,000 up until this week. (So for anyone thinking there's still room for this rally to grow -- 14,164 is the number you're shooting for. We're not fully "back" for another 1,100 points.)

All this does beg one question: Just what is this thing we call "the Dow" anyway? And when we say that it has hit 13,000... 13,000 whats? Is it 13,000 "points"? Or 13,000 dollars? What's all the fuss about, anyway?

A Brief Primer on the Dow

At its most basic level, the Dow Jones Industrial Average is a figment of The Wall Street Journal's imagination. Originally designed by the editor of the Journal on May 26, 1886, the Dow is an index that tracks the values of 30 of America's biggest companies. Today, it includes the following firms:

* Alcoa
* American Express
* Boeing
* Bank of America
* Caterpillar
* Cisco Systems
* Chevron
* DuPont
* Disney
* General Electric
* Home Depot
* Hewlett-Packard
* IBM
* Intel
* Johnson & Johnson
* JPMorgan Chase
* Kraft
* Coca-Cola
* McDonald's
* 3M
* Merck
* Microsoft
* Pfizer
* Procter & Gamble
* AT&T
* Travelers
* United Technologies
* Verizon
* Walmart
* ExxonMobil

As you can see, many of these 30 components of the Dow Jones Industrial Average have nothing to do with "industry" at all. American Express does credit cards. JPMorgan does banking. Kraft makes cheese. It wasn't always that way.

Nearly all of the companies named above are household names today, but when it was originally established, the Dow included firms such as American Cotton Oil Co., Distilling & Cattle Feeding Co., and U.S. Leather.

Never heard of them? That's not surprising. New names are added and subtracted from the index all the time as companies are born and die, merge and get acquired, declare bankruptcy, and restructure themselves. Indeed, the Dow components have changed dozens of times over the past century.

Getting to the Points

Any company that's part of the index in a given year has a stock price that's quoted on U.S. stock market exchanges. Add up the prices of the 30 stocks now on the Dow, though, and you'll find that they still fall far short of "13,000." Nor does the "13,000" relate to the market capitalization of the companies, as many people probably think.

In fact, the truth of the matter is that the Dow's value is calculated by a complex mathematical formula. At its simplest level it looks like this:

But in certain instances, such as when a company "splits" its stock or makes other changes that could mess up the formula, the Dow magicians have to use a formula as complex as this:

Clear as mud, right? OK, so let's make this simple: Basically, every time a stock on the Dow -- Caterpillar, let's say -- goes up in price by $1, the Dow adds 7.57 "points." Every time another stock -- let's stick with the C's and say Chevron -- drops by $1, the Dow loses 7.57 points. Add up all the changes, up and down, that happen to Cat, Chevron, and the other 28 stocks on the Dow on a given day, and multiply by 7.57, and this gives you the change in value of the index for the day.

This also means that just five companies with high share prices -- Caterpillar, Chevron, Exxon, IBM, and McDonald's -- out of the thousands of stocks listed on U.S. exchanges, make up nearly 4,600 of the Dow's points.

I Can See Clearly Now...

The Dow's climb back to 13,000 made a lot of headlines this week. Even with official unemployment at 8.3%, and many, many more people than that underemployed or too discouraged to seek a job anymore, the Dow's rise has a lot of people thinking that our economy has nearly recovered.

Don't believe it. Even if you can't follow the math of the equations up above, their complexity should make one thing clear: The Dow doesn't mean what many people seem to think it means. The stock prices of a handful of companies should not be taken as a true proxy for the American economy.

We may be back to "13,000," but we're not truly "back" just yet.

Motley Fool contributor Rich Smith does not own shares of any company mentioned above. The Motley Fool owns shares of JPMorgan Chase, Johnson & Johnson, Walmart, Microsoft, Coca-Cola, Bank of America, International Business Machines, Cisco Systems, and Intel. Motley Fool newsletter services have recommended buying shares of Coca-Cola, Microsoft, Johnson & Johnson, Pfizer, 3M, Walmart, ExxonMobil, Procter & Gamble, McDonald's, Chevron, Walt Disney, The Home Depot, and Intel. Motley Fool newsletter services have recommended creating a written covered strangle position in American Express. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft and creating diagonal call positions in Johnson & Johnson, Walmart and 3M.

Learn about investing from the comfort of your own home.

Portfolio Basics

Take the first steps to building your portfolio.

View Course »

Investment Strategies

Learn the strategies you need to build a winning portfolio

View Course »

Add a Comment

*0 / 3000 Character Maximum

49 Comments

Filter by:
Bonjour Monsiur!

Dji as an index not only cannot indicate economy situation, but , as misunderstood and far stretching so much, that it became one of tools for the Wall Street to paint wrong pictures. Plus, perpetration of the market by computerized trading, the less participation of individual investers, the easier for big manipulaters to rake in big profit.

March 04 2012 at 5:03 AM Report abuse rate up rate down Reply
Artie

great point!.

March 02 2012 at 10:00 AM Report abuse rate up rate down Reply
Artie

Why is it that when the DOW hits 13000 it's meaningless, but when it falls below 10000...the sky is falling? Wake up folks, the people who bring you this article are a contradiction...either the DOW is an indicator of something or it isn't. It appears that they are just trying to make you afraid of something or not to believe something so that they can SELL you something! Wake up! I'll bet these people are probably selling insurance and used cars as well.

March 02 2012 at 9:59 AM Report abuse rate up rate down Reply
flmbobby

Finally someone tells the truth about the BULLCRAP market.As I have said all along this great 13000 does not create the first job or help a working individual at all

March 02 2012 at 7:50 AM Report abuse rate up rate down Reply
Margi Chin

What does dow 13,000 mean to me? Means maybe if it continues, I will recoup what I lost back in 2008. You think?

March 02 2012 at 7:18 AM Report abuse rate up rate down Reply
Margi Chin

What does dow 13,000 mean to me? Means maybe if it continues, I will recoup what I lost back in 2008. You think?

March 02 2012 at 7:18 AM Report abuse rate up rate down Reply
Master Sixkiller

Hope you all like the feel good news just because the DOW is up doesn't mean Main Street is back to normal. So enjoy the feel good about the economy news.

March 01 2012 at 11:00 PM Report abuse rate up rate down Reply
Iselin007

Gas (Reg )was selling at 34 9/10 per gal. in NJ in 1971 but a few years later the 2nd gas crisis raised it to 67 9/10 an it's been going up ever since.

March 01 2012 at 10:11 PM Report abuse rate up rate down Reply
chrisgiddyup06

And gasoline has far outpaced inflation when you take into account what high energy does is pushing up the prices on everything else. Now with companies having to pay more in energy that means they have to let people to stay afloat or decrease wages to keep all employed. Less people employed less goods sold. Less goods sold less people needed to make them which means more unemployment. NOW lets add in the home energy costs too. heat the house and feed the kids or buy something with that extra few buks left over? Oh Wait ! That extra is now eaten up by higher energy costs and with a decrease in wages.

But we have a President who is so smart that he considers high energy prices only a minor blip in the economy. How is the hell did you people ever vote for this idiot?

March 01 2012 at 9:46 PM Report abuse rate up rate down Reply
chrisgiddyup06

13,000 means nothing when unemployment is this high. Now lets add in inflation for food and basic substance to live, devalued housing, increased insurance, and a devalued dollar thanks to the non stop printing to pay Barry's added expenses. Wages are also dropping across the board. So 5 dollar gas hurts the poorest the most. It helped kill the middle class. More Americans are on food stamps and government handouts then ever before. Thank you Obama. Things are much worse then his propaganda press will ever report.

But hey, King barry and the propaganda press say 13,000 is a good thing so all must be right now in the world.

March 01 2012 at 9:40 PM Report abuse rate up rate down Reply