What Is the Dow Divisor?
The Dow Divisor is a number used to calculate the Dow Jones Industrial Average (DJIA) value. Because the Dow 30 is price-weighted, the Dow Divisor normalizes the value, making it more manageable and easier to track.
The DJIA index is price-weighted, unlike most other indices that are weighted by market capitalization. This fact means that stocks with higher share prices are given more weight in the index. It is calculated as the sum of the prices of all 30 companies divided by a factor.
The factor is referred to as the Dow Divisor.
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How is the Dow Divisor Used?
The value of the DJIA is calculated by the sum of the component stock prices divided by the Dow Divisor. The equation is,
DJIA Value = Sum of DJIA Stock Prices / Dow Divisor Value
For example, the intraday sum of all 30 stock prices was $5076.86 on January 18, 2022. The current value (as of March 7, 2022) of the Dow Divisor is roughly 0.15172752595384, as reported by Barron’s Market Lab. Applying the above equation gives a value of 33,460.34. The Dow Jones Divisor is published daily in the The Wall Street Journal and Barron’s Market Lab.
Because the value is below one, it acts as a multiplier. When a stock price increases, the effect is amplified by the Divisor. For instance, if the stock price of Coca-Cola (KO) increases by $1 per share, it causes the DJIA value to increase by 6.590761918204806 ($1 / 0.15172752595384).
For this reason, higher-priced stocks have a greater weighting on the Dow 30. When two equities with different stock prices increase by the same percentage, the higher-priced one has a more significant effect on the DJIA.
History of The Dow Divisor
When the DJIA was first created on May 26, 1896, by Charles H. Dow and Edward Jones, the value was set at 12, the number of constituent stocks in the index. Hence, the DJIA was an actual average.
Stock splits were handled by weighting the price to the pre-split basis. So, if Stock A was $10 and a 2-for-1 split changed the price to $5, a weighting factor of 2 was used to maintain the continuity of the DJIA’s value.
In 1916, the number of stocks was expanded to 20. In 1928, William Peter Hamilton, the editor of the The Wall Street Journal, reworked the DJIA, dropping several names and expanding the list to 30. He also changed the method of handling stock splits. Instead of weighing the post-split price of an equity, the split price was employed in the DJIA, and the Divisor was adjusted to maintain continuity.
The initial value of the Dow Jones Divisor was set at 16.67 to stabilize the DJIA’s value between the old and new methods.
Through the years, the Divisor required periodic adjustments to maintain continuity in the Average for stock splits, dividend payments, spin-offs, and additions or deletions to the index. Consequently, the value has ranged from a high of 16.67 in 1928 to a low of 0.147 in 2019. The value fell below one in 1986.
The current Dow Divisor value is 0.15172752595384.
Today, the S&P Dow Jones Indices and the The Wall Street Journal calculate the DJIA using the new method. The equation used in determining the new value is,
DJIA Value = (Old Sum of DJIA Stock Prices / Old Dow Divisor Value) = (New Sum of DJIA Stock Prices / New Dow Divisor Value)
According to the S&P Global website,
“The Dow Jones Industrial Average is maintained by the Averages Committee. The Committee is composed of three representatives of S&P Dow Jones Indices and two representatives of The Wall Street Journal.”
“Each committee meets regularly. At each meeting, the Committee reviews pending corporate actions that may affect index constituents, statistics comparing the composition of the indices to the market, companies that are being considered as candidates for addition to an index, and any significant market events. In addition, the Committees may revise index policy covering rules for selecting companies, treatment of dividends, share counts or other matters.”
Example of a Split
Here’s an example using three companies: X, Y, and Z:
Company X’s stock price is $10.
The Company Y’s stock price is $20.
Company Z’s stock price is $30.
Their average is $20: (A + B + C)/3 = $20
Assume Company Z conducts a 2-for-1 stock split, doubling the number of shares and making the stock price $15 per share.
In this example, the old Divisor value is 3. Therefore, it must change to 2.25 to keep the average unchanged after Company Z’s stock split.
$20 = ($10 + $20 + $30)/3 = ($10 + $20 + $15)/2.25
Issues with the Dow Jones Divisor
The primary issue is the Divisor needed to be consistently adjusted for dividends and corporate actions in the past. Hence, the DJIA value is underreported and underestimates long-term total returns.
Second, the Divisor was rounded in the past, introducing errors in the calculations.
Finally, a single equity with strong upward or downward price movement can significantly affect the Average.
The Dow Jones Industrial Average is an imperfect index, but it is well-followed because it contains some of the most important companies in the United States. The Dow Jones Divisor makes tracking and managing the index simpler. The last change was in 2021 when International Business Machines (IBM) spun off Kyndryl (KD).
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.