`How, now, Dow?' A look at a rough but ready market gauge

``How's the market doing today?'' ``Well, so far it's up five points.''

Conversations like that are heard throughout the trading day, as investors and observers of the stock market speak in verbal shorthand.

``The market'' here is actually the Dow Jones industrial average. And while an index of 30 companies is hardly representative of the more than 2,000 stocks on the New York Stock Exchange, or the tens of thousands of stocks traded throughout the United States, the ``Dow'' remains the most commonly used measure of the stock market.

If many professional market-watchers had their way, however, that would change.

``It's a careless, lazy way to approach the market,'' says Larry Wachtel, a vice-president with Prudential-Bache Securities Inc. Even though the fast-talking analyst is often called upon by harried reporters on Friday afternoons for a quick, scribble-forcing comment on the Dow's weekly performance, Mr. Wachtel holds the index in disdain.

``I think it's become more and more of an anachronism,'' he says. Besides being too small a sample to give an accurate picture, he explains, the index can be too easily changed by the performance of one company. As an example, he points to the pending takeover of General Foods -- one of the 30 companies in the Dow -- by Philip Morris. As that takeover moved from speculation to near-reality, the rising price of General Foods' stock pushed the average up.

In one week, Wachtel says, the average went up more than 22 points, ``almost entirely based on General Foods.'' In that week, he adds, the prices of 18 stocks in the index were down, 10 were unchanged, and 2 went up. Without General Foods, it is estimated the Dow would have fallen about two points, joining most other indicators on the downside.

Other analysts aren't much kinder to the oldest of the stock market indexes, even though it has been in continual use -- with many revisions -- since 1884.

``I think it's the worst indicator,'' says Norman Fosback, editor of Market Logic, a newsletter published in Fort Lauderdale, Fla. ``It's just 30 stocks and not a representative 30.'' The index gives too much weight to old-line manufacturers, when the economy is getting more service-oriented, he maintains. ``You have to look at the Dow and the broader average,'' including the Standard & Poor's (S&P) 500, the New York Stock Exchange (NYSE) index, and the comparison of advancing prices vs. declining o nes (over time, it's called the advance-decline line), says William H. Pike, a vice-president and portfolio manager at Fidelity Investments in Boston. Mr. Pike is also the author of ``Why Stocks Go Up (and Down)'' (Dow Jones-Irwin).

The famous index has been coming under new criticism lately for another reason. As professional traders use complex strategies involving options or futures contracts on stock indexes and individual stocks within the indexes, the activity that follows can send the Dow zipping off in directions that are unexpected and unrelated to overall investment performance.

If the Dow is so lacking as an indicator, then why are its movements followed so closely and its latest level quoted on every nightly newscast?

``Mr. Dow and Mr. Jones were the first,'' Pike explains. ``The index was well thought out. If you want a picture of how the stock market has done throughout this century, it's all you've got.''

Charles Henry Dow's first index included only 11 stocks. Reflecting the major players in US business at the time, nine of them were railroads. Mr. Dow's average was just that, an average where the prices of the 11 stocks were added up and divided by 11.

Over the years the average grew to 20 stocks, then to 30 industrial companies in 1928. Since then, the stocks in the group have changed; some of the original 30 industrials are still there, though they may have different names. Standard Oil of New Jersey, for example, is now known as Exxon, and the soon-to-be-replaced General Foods joined the list as Postum. Others like Allied (now Allied-Signal), General Motors, American Can, and Texaco are still there, with more or less their original names. But Nash Motors, Wright Aeronautical, and Victor Talking Machine are just memories.

When General Foods is formally merged into Philip Morris, a replacement will have to be found for its spot on the list. If the past is any guide, the statistical department of Dow Jones & Co. will select a corporation in a similar line of business. Quaker Oats or Pillsbury might be likely candidates, Mr. Wachtel guesses.

At least one company, IBM, has been on the list only to be removed and then brought back. The company was bumped off the list in the 1930s, Mr. Fosback points out, and was not readmitted until the mid-1970s. This meant that IBM's years of greatest growth were not a factor in the industrial average. Had it remained throughout, he estimates, the average would be 30 to 40 percent higher than it is today.

The method of computing the Dow Jones average has changed, too. The stock prices are still added up, but they are no longer divided by 30. Instead, a divisor is used. That divisor is also changed occasionally, usually to reflect a stock split.

The divisor is now at 1.116. This means if the prices of the 30 industrial stocks added up to $1,479.50, the Dow Jones industrial average (DJIA) would be quoted as 1,325.72.

In addition to the 30 industrials, there are Dow Jones averages for 20 transportation stocks and 15 utilities and a composite of all 65 of these. These lists each have their own divisors, and all four divisors are published daily in the Wall Street Journal.

Still, it is the 30 industrials that are followed so closely and quoted so frequently. And if you follow the daily movements of the industrial average over a long time, you are getting a fairly accurate, if incomplete picture, Mr. Pike says.

In addition to the Dow, he also looks at the broader S&P 500, the NYSE index, and the advance-decline line. Pike believes it is possible, though, to put some interpretation on particular movements in the DJIA (see accompanying table).

And, like many of us, he will probably continue to peek at the Dow Jones industrial average when he wants a quick reading of how ``the market'' is doing. ``If I want to know more, I look at the other indexes, but I always start with the Dow,'' he says. CHART: How to read changes in the Dow Changes in DJIA Up more than 16 Up 10 to 16 Up 5 to 10 Up 2 to 5 Up 2 to down 2 Down 2 to 5 Down 5 to 10 Down 10 to 16 Down more than 16 Interpretation Unusually strong gain Sharp gain Good gain Modest gain Essentially unchanged Modest decline Very weak Off sharply Major decline Source: ``Why Stocks Go Up (and Down),'' by William H. Pike. CHART: Companies in the Dow Jones industrial average Allied-Signal, Alcoa, American Brands, American Can, American Express, AT&T, Bethlehem Steel, Chevron, Du Pont, Eastman Kodak, Exxon, General Electric, General Foods, General Motors, Goodyear, Inco, IBM, International Harvester, International Paper, Merck, Minnesota Mining & Manufacturing, Owens-Illinois, Procter & Gamble, Sears, Roebuck, Texaco, Union Carbide, United Technologies, US Steel, Westinghouse, Woolworth