Good question by NPR’s Planet Money co-founder Adam Davidson. More specifically, Davidson wants to know why the Dow is still used as the primary barometer for America’s economic health.
The Dow average, drawn out to two decimal places, may seem like some perfectly scientific number, but it’s far from it. A small committee selects 30 big companies — I.B.M., G.E., McDonald’s, Disney and so forth — and then adds up the price of their stocks. Then the analysts divide it by the Dow Divisor, a misleadingly precise-seeming number formulated to account for things like dividends and splits that right now is, well, about 0.132129493. The resulting figure is repeated throughout the country.
And those are the least of the Dow’s problems. More troubling is that it ignores the overall size of companies and pays attention to only their share prices. This causes all sorts of oddities. ExxonMobil, for example, divides its value into nearly five billion lower-cost shares, while Caterpillar has around 650 million more expensive ones. Therefore ExxonMobil, one of the largest companies in history, pulls less weight on the Dow than a company less than a fifth its size.
Davidson also points out that the Dow doesn’t adjust for inflation — so passing the 12,000 mark means less in 2012 than it did in 2006 — nor does it add or subtract companies with any sort of frequency. Apple is not trading on the Dow, but Microsoft is. It also doesn’t factor in things like environmental impact, the global economy, etc.
Actually, when you really look at the stock market as an economic indicator it makes less sense the more your look into it. I think. I’m not really sure. I feel more knowledgeable by Davidson’s piece, but also more confused. [via DF]