Jan 8, 2014

Stock Buy Break it Down - 3, The Dow Joneser

The market's blood pressure and cholesterol are measured by stock market indexes.

Dow Jones Industrial Average, S&P 500 and NASDAQ Composite are the three stock indexes you hear daily on the news.  These tools all do the same thing:  calculate a weighted average of various stock prices to provide investors with an overall picture of how the market is doing.

An increase in the Dow, S&P 500 or NASDAQ means the market is doing well.  Stocks generally increased in value that day and investors are happy.  Multiple days of a hard charging rise is a bull market.  Investors are optimistic and the charts are green.

A decrease in the Dow, S&P 500 or NASDAQ means the market sagged, stocks generally deflated in value that day. A pattern of days of flaccid stocks is a bear market.  Investors are pessimistic and the charts glow red.

Here's a snapshot of today's Dow Jones (blue), S&P 500 (red) and NASDAQ Composite (yellow).  In the top right corner, notice the Dow (-.41%) and S&P (-.02%) were down slightly, the NASDAQ (+.30%) was up a bit:



Stock indexes and unemployment numbers are the dials of how well the economy's doing.  

Check the Dow Jones chart during the Depression.  Brutal drop in stock values in 1932 and 1933, the market didn't fully recover until 1954:



Everybody should give stock indexes an occasional glance.  See below, the housing crash and dip in 2008/09 directly corresponded to tanking stocks and companies laying off scads.  It took five years for the market to recover to pre-2008 levels.  That's painful.



I'll do a rundown of how the three stock indexes are calculated, then you kids better get to bed.

Dow Jones Industrial Average
Charles Dow birthed the Dow Jones Industrial Average in 1896, the oldest of stock indexes.  This index is a modified average of the stock prices of 30 large companies in the U.S.  Every $1 change in price of a stock in the Dow results in a 6 point Dow movement.  

The Dow started with a value of 28 in the 1890s...today it nips near record highs of 16,500.  

Here are the 30 companies that make up the Dow Jones.  Most of them trade on the NYSE, only three are NASDAQ:


General Electric is a beast, the only company surviving the list since the beginning.  Even back when the Dow was represented by only 12 companies in the 1890s.  General Motors sucks and was kicked off the Dow in 2009, replaced by techno company Cisco.

My opinion is the Dow has too little representation of tech/NASDAQ companies on it to be an accurate market indicator.  Tech is where much money is turned these days:  Apple, Amazon, Tesla, Netflix.  The Dow police should consider swapping out a few crusties for newer, stable tech companies.  For example, we don't need both ExxonMobil and Chevron on the list of 30, and why doesn't Google make the cut?

S&P 500
The Standard and Poor's 500 is a stock market index based on the weighted market capitalization of 500 large companies (listed here) that trade on the NYSE and NASDAQ.  The S&P 500 is younger and created 60 years after the Dow Jones, but many consider it a more accurate indicator of stock market health since it summarizes performance of 500 companies vs. the Dow's 30.

A company's market capitalization is simply the stock price multiplied by number of shares.  If a company issues 1 million shares of stock, and each share sells on the market for $23, the market cap' is 23 million.  The S&P 500 measures the market capital of 500 companies and applies modifiers so larger companies are weighted more heavily.  The S&P 500 had a value of 16 when it started in 1957.  Today, it's near record levels of 1,900.

I like the S&P's large number of companies it tracks, and it represents a diverse spread of stocks between the NYSE and NASDAQ.  It mostly measures American stocks, only 27 of the 500 companies are non-U.S. companies.  So it's not an accurate indicator of world markets.

NASDAQ Composite
The NASDAQ Composite is similar to the S&P 500:  an index based on the weighted market capitalization of a pile of companies.  Difference is the NASDAQ Composite only includes stocks that trade on the NASDAQ (not the NYSE), and it measures ALL stocks on the NASDAQ, representing over 3,000 companies.  

The NASDAQ Composite peaked during the Y2K frenzy of 1999 into 2000, tapping out a score of 5,100.  By 2002 and the dot-com bust, it plunged to a value of 1,100.  The Composite score still hasn't recovered to that peak 1.5 decades ago, today it sits at 4,100.

The good thing about the NASDAQ Composite is it represents more non-U.S. companies than the Dow Jones or S&P 500, for a wider world view of the markets.  Unlike the Dow, it fully covers tech and growing companies.  The downside is the Composite doesn't monitor any stocks listed on the NYSE.

Trends
The Dow Jones, S&P 500 and NASDAQ have all continued to rise over time.  

There have been depressions, bull runs, recessions and drives along the way.  But for the long haul, investors generally come out with more money than they put in.  

Below is the S&P 500 for the past 30 years.  Look at the current value vs. the early 1980s.  If you bought the right stocks 30 years ago and sold them today, you'd have a nice baggy of cash to fund retirement.  Just invest aggressively enough to outpace inflation, and keep an eye out for the duds. #enron



-Beard

8 comments:

  1. Anonymous1/09/2014

    first

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  2. I don't own stock and have learned a lot through this series. I appreciate it! Maybe I'll be brave enough to take the leap someday!

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    1. Thanks, pretty sure I'm putting readers to sleep with this series, but who cares.

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  3. Anonymous1/11/2014

    Your advice on this subject is priceless. Way to go. I still have a headache trying to sort it all out, but your explanations are spot on. Thanks for the education.

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    1. I think nearly everyone can end up with a sizable amount for retirement if they follow these 3 simple rules:

      1) Start saving when you are young.
      2) Have the money you are setting aside for retirement taken out of your paycheck automatically, so it's consistent and you'll learn to not miss the money.
      3) Invest aggressively. Being too timid increases risk.

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  4. I hope 2014 proves to be a good year for you and yours!

    ReplyDelete
  5. During this time, a banker named Charles Mitchell announced his bank would continue to make loans, thus relieving some of the panic. However, this wasn't enough to stop the inevitable crash as fear swept across the nation like a raging wildfire.guarantor loans

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Thanks for the note, check back for my response!