Understanding Dow Jones industrial average

Motley Fool

Q: The Dow was recently at 25,600. What, exactly, does that number represent? — M.M., Decatur, Illinois

A: “The Dow” refers to the Dow Jones industrial average (DJIA), a U.S. stock market index established in 1896. It’s an average of the stock prices of 30 companies that include Apple, Boeing, Coca-Cola, The Home Depot, McDonald’s, Nike, Procter & Gamble, Walmart and Visa. It doesn’t look like an average, though, when it’s 25,600 and many of the stocks sport prices below $100.

It makes sense, though, because the shares, on average, actually would trade at lofty levels — if they had never been split, issued dividends or undergone major changes such as spinoffs or mergers during their time in the index.

Therefore, in order to account for all those changes, the stock prices of the 30 component stocks are added together and then divided (the “divisor” is adjusted frequently and was recently 0.14748071991788). To understand how each stock affects the average, know that if, say, Visa stock rises by $10, you can just divide 10 by the divisor and learn that the DJIA will rise by about 67.81 points (10 divided by 0.14748071991788 equals 67.805).

Fool’s school: When to sell stocks

When the price of a particular stock suddenly drops sharply, many shareholders rush to sell it. Many sell stocks when the market suddenly heads south, too. Those can be costly mistakes, though.

Don’t sell just because a stock or the market is falling, or you’ve heard some rumors, or someone tells you to sell. Here are good reasons to consider selling:

• If you can’t remember why you bought the stock.

• If you can’t explain how the company makes money.

• If you hold too many or too few stocks. Portfolios should be diversified, but not too diversified. Aiming for eight to 15 companies is good for most people.

• If the reason you bought shares is no longer valid. For example, maybe the company is suddenly facing strong competition.

• If the stock seems significantly overvalued. Consider the tax consequences, though.

If you expect it to keep growing over the long run, hanging on can be best.

• If you find a much more attractive investment. If your calculations suggest that a holding is now fairly valued and stock in another great company appears to be very undervalued, you could gain more in the other stock. (Again, consider tax effects, though.)

• If there are red flags such as shrinking profit margins or steep debt. Short-term problems can be OK, but look out for long-term ones.

• If you’ll need that money within five (or even 10) years, it should be in a less volatile place than stocks. Consider a money market account or a CD.

• If you’re only hanging on for emotional reasons.

Focusing only on whether to buy a certain stock and not giving much thought to when you should sell it is a costly blunder. If you leave your dollars in a poor investment, they can’t grow for you in a great one.

Name that company:

I trace my roots back to 1993, when two Circuit City executives formed me to diversify the company’s operations. I was envisioned as a company with a massive inventory of cars offered at a then-revolutionary “no-haggling” price. I was spun off from Circuit City in 2002. Today, based in Richmond, Virginia, I’m America’s biggest used-car retailer, with more than 190 stores in 41 states. I employ 25,000-plus people. My annual revenue tops $17 billion. In my most recent fiscal year, I sold more than 700,000 used vehicles as well as more than 400,000 wholesale vehicles at instore auctions. Who am I?

Last week’s answer:

I trace my roots back to the 1920s, when two brothers in Germany started making shoes in their mother’s laundry room. Jesse Owens won gold in the 1936 Olympics with my shoes. The brothers parted ways in the 1940s, with one setting up the Puma brand and the other registering my name as a brand — and patenting a striped logo, too. My lightweight soccer shoes with screw-in studs helped Germany win the 1954 World Cup. I introduced track suits in 1967 and bought Reebok in 2006. I produce more than 900 million items annually. Who am I? (Answer: Adidas)