Yesterday, I set out to discover exactly how the DJIA is calculated. Turns out that it is pretty simple; it actually is an average. They take 30 stocks, add up the price of all of the stocks, and divide by a "Dow divisor". The value of the divisor is determined by the Wall Street Journal. It's actually less than one, which means that the sum of all of the stock prices is actually multiplied by about seven to get the number you see.
So, the Dow changes if the company stock prices go up or down ... or if the folks at the WSJ decide to adjust the Dow divisor. They are suppose to adjust the divisor to account for stock splits, dividends and other events that affect stock prices, but I couldn't figure out who or what exactly goes into this. If the WSJ folks fail to take something into account, for example stock buybacks, the DJIA could rise or fall even though a company's value did not change.
Consider two Dow stocks, Boeing and Pfizer. Boeing has the top price in the Dow today, around $330. Pfizer is dead last around $40. So a drop in Boeing of around $40 would do the same damage to the DJIA that Pfizer would do if it dropped to zero. But Pfizer's market cap is actually higher than Boeing. A $40 drop in Boeing would destroy about $22 billion in wealth, but a $40 drop in Pfizer would wipe out $220 billion.
It seems crazy to base a well known index on stock prices rather than market cap. The top six Dow companies by price (Boeing, Apple, UnitedHealth, Goldman Sachs, Home Depot and McDonalds) combine for more than a third of the value of the DJIA. The bottom six (Intel, Coca-Cola, Walgreens, Dow Chemical, Cisco and Pfizer) have less combined influence than either Boeing or Apple do alone.