What is Dow Divisor
The Dow Divisor is a numerical value computed by Dow Jones Indexes that is used to calculate the level of the Dow Jones Industrial Average (DJIA). The Dow Divisor is critically important in calculating the level of the DJIA, which is obtained by summing up the prices of its 30 component stocks and dividing this figure by the Divisor.
BREAKING DOWN Dow Divisor
The Dow Divisor is used to maintain the historical continuity of the index, since there have been numerous stock splits, spinoffs and changes among the Dow constituents since the index was first introduced in 1896. The Dow Divisor is adjusted in case of stock splits, spinoffs or similar structural changes, to ensure that such events do not in themselves alter the numerical value of the DJIA.
The value of the Dow Divisor has changed significantly over the years. For example, it was at 16.67 back in 1928, but was at 0.132129493 as of July 2010. As of The values of the Dow Divisor as well as divisors for the other Dow Jones indexes are published daily in The Wall Street Journal.
For example, if the sum of the prices of the 30 constituents of the DJIA is 1,650, dividing this figure by the Dow Divisor of 0.132129493 would provide a level of 12,487.75 for the index. As of September 1, 2017, the Dow Divisor was 0.14523396877348 on September 1, 2017. Using this Divisor, every $1 change in price in a particular stock within the average equates to a 6.885 (or 1 ÷ 0.14523396877348) point movement.
Most corporate actions such as stock splits and spinoffs have served to push the value of the Dow Divisor lower. The fact that the Divisor is now well below one means that the divisor actually functions as a multiplier!
How the Dow Divisor Works
At first, the Dow Divisor was composed of the original number of DJIA companies; which made the DJIA originally a simple arithmetic average. The present divisor, after many adjustments, is less than one, which means the index is larger than the sum of the prices of the components. That is:
where p are the prices of the component stocks and d is the Dow Divisor.
Events such as stock splits or changes in the list of the companies composing the index alter the sum of the component prices. In these cases, in order to avoid discontinuity in the index, the Dow Divisor is updated so that the quotations right before and after the event coincide: