<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (April 9, 1998) -- We talk about it every day. We know vaguely which companies are in it. We know that if we're long and it's going up, we're happy. But just how is it -- the Dow -- calculated?

The Dow has a long history, so its not surprising that the calculation for the index is pretty technology-free. In fact, when Charles Dow was toting up the results each day, it had to be done quickly and by hand to get posted in the early versions of what is now The Wall Street Journal. So believe it or not, the method for calculating the Dow is as simple as adding up the stock prices of the 30 companies. Well, it's actually one step more complex than that, but only one step.

If the original stocks in the index had never changed, or spun off divisions, or split their shares, it would be as simple as adding up the 30 stocks prices, but Dow had to account for the inevitable changes in the index. When a stock drops out at $95 a share and it's replaced by a stock at $25 a share, there's no reason for the index to drop as a result.

So Dow instituted a flexible divisor, which can be adjusted for each new index event (stock splits, etc.) in order to keep the value of the index before and after the special event identical. To calculate the DJIA value today, one adds the 30 stock prices and then divides by this floating factor, currently approximately 0.25. That's all there is to it.

With the divisor at roughly 0.25, every dollar in movement in any one stock moves the index by roughly four points. So when DuPont <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DD)") else Response.Write("(NYSE: DD)") end if %> jumped $4 in a session this week, for example, it raised the Dow by 16 points.

The unfortunate aspect to this calculation method, of course, is that it favors higher-priced stocks over cheap ones. If a $100 stock moves by a point, that represents only a 1% gain for that stock. If a $20 stock moves $1, however, it represents a 5% gain for the stock. Yet both moves of $1 affect the index precisely the same amount -- roughly 4 points. Doesn't seem right, does it? Nevertheless, it's been done this way for so long, it's unlikely to change.

For our own records, however, we track the Dow 30 on an even basis in our 1998 Dow Returns file. The figure we call the Dow 30 is that of all 30 stocks, equally weighted, plus their dividends on the year. So a $20 stock and a $100 stock will have the same chance of influencing the index.

Fool on!

Current Dow Order | 1998 Dow Returns

[Robert Sheard is the author of the forthcoming book, The Unemotional Investor, due out from Simon & Schuster on May 12. To pre-order your copy, please visit Amazon.com, where it's available at a discounted price.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   +  11/16  50.63 
 IP   +   3/16  48.19 
 MO   +   3/4   40.50 
 EK   +   1/8   64.06 
 
 
                    Day   Month    Year 
         FOOL-4   +0.92%   0.09%   6.90% 
         DJIA     +1.16%   2.22%  13.74% 
         S&P 500  +0.82%   0.81%  14.45% 
         NASDAQ   +0.73%  -0.85%  15.91% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  291 Union Carb    42.94     50.63    17.90% 
  12/31/97  289 Int'l Pape    43.13     48.19    11.74% 
  12/31/97  206 Eastman Ko    60.56     64.06     5.78% 
  12/31/97  276 Philip Mor    45.25     40.50   -10.50% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  291 Union Carb 12494.81  14731.88  $2237.06 
  12/31/97  289 Int'l Pape 12463.13  13926.19  $1463.06 
  12/31/97  206 Eastman Ko 12475.88  13196.88   $721.00 
  12/31/97  276 Philip Mor 12489.00  11178.00 -$1311.00 
  
  
                              CASH    $415.96 
                             TOTAL  $53448.90