Index and the DJIA essay sample

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Index and the DJIA

There are several stock market indexes that have been developed in order to measure the financial performance of organizations in the economy. The Standard and Poor’s 500 Index (S&P 500 Index) and Dow Jones Industrial Average (DJIA) are some of the stock market indexes commonly used in the United States (U.S.).

The DJIA was the first index that got published in 1896 and comprised some of the top publicly traded American companies (Ehrhardt and Brigham, 26). The index was developed by Charles Dow and only consisted of twelve companies. Currently, there are thirty companies that make up the DJIA and the index is seen as the bellwether of how the broader market is performing. The companies in the list are occasionally replaced by the editors of The Wall Street Journal based on the market conditions.

For example, the editors replaced Eastman Kodak and International Paper with Pfizer and Verizon in 2004 (Ehrhardt and Brigham, 26). On the other hand, the S&P 500 Index was first published in 1957 and is weighted by market capitalization and designed to be a representative of a broad domestic economy. The index captures 75 percent of the American stock market and comprises 500 leading companies from various industries. All the listed companies under the DJIA are also part of the S&P 500 index.In comparison, both indexes represent the performance of the broader economy. The performance of the indexes in terms of the gains and losses usually appear to be close but upon close look at their long-term performance, an individual gets to realize that the S&P 500 Index outdoes the DJIA. For example, in July 2013, the Morningstar reported that the DJIA had gained by 13 percent while the S&P 500 Index gained 21 percent. The DJIA is a price-weighted average and, in this case, a company that has its stock price highly included will have a bigger impact of its price movement on the overall index. Although the DJIA uses the term ‘industrial’, the fact is that it is really broader than that. The industrial sector contributes for only up to twenty percent of the DJIA.

Moreover, the index does not contain stocks of companies in the utility sector since there are separate Dow Jones indices that cover such sectors.On the other hand, S&P 500 Index is a market-cap-weighted average that is far more inclusive compared to the DJIA. In this case, each stock affects the index in the proportion of its market valuation (Ehrhardt and Brigham, 26). As a result, calculation of the index in this manner results to the total capitalization of accompany as a determinant of the index but not the stock price as observed in the DJIA.

The major goal of the S&P 500 Index is to represent the broad U.S. economy and comprises 500 American companies selected by the S&P Dow Jones Indices (Ehrhardt and Brigham, 26). The companies have to meet certain set criteria before getting listed in the S&P 500 …

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