What Is the Dow Divisor?
The Dow divisor is a numerical value used to calculate the level of the Dow Jones Industrial Average (DJIA). The DJIA is calculated by adding up all the stock prices of its 30 components and dividing the sum by the divisor. However, the divisor is continuously adjusted for corporate actions, such as dividend payments and stock splits.
- The Dow divisor is a figure used to normalize the value of the Dow Jones Industrial Average (DJIA) given the prices of its 30 component stocks.
- The Dow divisor is regularly updated to ensure that structural changes to the market do not influence the DJIA’s validity as a benchmark index.
- For example, the Dow divisor may be changed as a reaction to stock splits, the altering or payment of dividends, and other events.
- The Dow divisor currently is below one, which technically makes it a multiplier.
How the Dow Divisor Works
The Dow divisor is used to maintain the historical continuity of the DJIA 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 maintains continuity by factoring in the many changes that take place within the market, such as stock splits and changes to—or payments of—dividends.
The Dow divisor is adjusted to ensure that such events do not, in and of themselves, alter the true numerical value of the DJIA. Because of major changes that have taken place within the market, the value of the Dow divisor has changed significantly over the years. For example, it was at 16.67 back in 1928, but has been as low as 0.147 as of Sept. 2019.
The Dow is named after Charles Dow, a founding editor of The Wall Street Journal, who, in 1896, partnered with statistician Edward Jones to form the first version of the DJIA. Since this time, The Wall Street Journal has been tasked with ensuring that the Dow divisor is adjusted properly to maintain the DJIA’s historical accuracy.
Keeping the Dow divisor properly updated assists traders and investors in making educated decisions by providing them with accurate market averages.
Events such as stock splits or changes in the list of the companies composing the index can often alter the sum of the component prices. In these cases, and in order to avoid discontinuity in the index, the Dow divisor is updated so that the quotations right before and after the event coincide.
Most corporate actions, such as stock splits and spinoffs, have served to push the value of the Dow divisor lower. At first, the Dow divisor was composed of the original number of DJIA companies, which made the DJIA a simple arithmetic average. However, as certain events have taken place to alter the overall value of the market, the Dow divisor has been manually altered in order to ensure that the DJIA is accurately valued.
The divisor fell below 1.0 in 1986 for the first time. 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. The fact that the divisor is now well below one means that the divisor now functions as a multiplier, rather than a divisor.
Example of the Dow Divisor
Let's say you sum up the prices of the 30 constituents of the DJIA, and arrive at 4,001. Assume that the Dow divisor is set at 0.147: using this divisor, every $1 change in price in a particular stock within the average equates to a 6.8 (or 1 ÷ 0.147) point movement.
Dividing this figure by the Dow divisor of 0.147 would provide a level of 27,218 for the index. Note that you divide by the divisor and not the number 30, which is the number of names in the index.