As those of you who have read my book know, I’m a firm believer in the power of looking at the daily closes of the Dow Jones Industrial Average and comparing it to the price of an ounce of gold. For those of you who don’t know, the Dow Jones started as a simple average of the share price of all of the companies that comprise it; for example, if there were three companies on the comprised the Dow average that had share prices of $5, $10, and $15, then the average would simply be $10.
Over the years, the number of Dow companies that comprise the Dow has risen from the original twelve to now include thirty different industrial companies. Since it’s simply an average of the number of companies, expanding the number didn’t have much impact. it’d be similar to looking at the average test score for classes of different sizes: more or fewer students don’t matter as we’re looking at an average. The reason the Dow Jones Industrial Average (DJIA) is such a large number in comparison to the stocks that comprise it is that those stocks have had numerous splits throughout the years while the Dow has not. Rather the Dow simply corrects for splits so as to maintain a continuous average throughout time. Just as the price of a single share of Microsoft stock would be $8928 at the close of 2007 if it had never split, the DJIA is a average of companies with such share prices. Continue reading The Dow-Gold Ratio Renders Its Verdict