Taking Stock of the Stock Market

A lot has changed since Dow and Jones teamed up in 1896

A few years ago, tracking your stock market investments required a simple review of daily values in The Wall Street Journal or your local paper. Today, minute-by-minute value updates and media hype make most individual investors feel like they’re on a roller coaster going out of control. Let’s step back and try to regain our “consumer confidence” by looking at the big picture.

Although the volume of shares controlled by major fund managers very likely causes some of the major “swings” in the Dow Jones, the market is still a historically good investment for the individual or single company. From 1926-96, the average annual return from the market was 10.72 percent, compared to 5.5 percent from the same investment in bonds. Not bad, considering returns ranged as low as -15 percent in the decade following the 1929 crash.

As any financial manager will advise, stable returns require long-term investment plans. Allocating assets among categories of stocks, bonds, government issues and cash funds depending on your risk tolerance and targeted retirement age really is the best method of investing successfully over the long term. In fact, 92 percent of the result is influenced by this “asset allocation” plan, while only 3 percent is affected by selecting individual stocks. Only 2 percent of your return is influenced by attempts to “time the market” by pulling your money out and reinvesting according to its cycles. Compare that to the 3 percent influenced by luck, and you’ll see why individual investors don’t fare especially well in trying to “beat the market” themselves.

The most popular overall measure of the market is the Dow Jones Industrial Average (DJIA). In 1896, Charlie Dow and Ed Jones picked 12 stocks and averaged their per-share closing prices to produce the first daily average of $40.94, which they published in their daily paper, the Customer’s Afternoon Letter (which became the Wall Street Journal). The original 12 included cotton, sugar, tobacco, feed, fuel, manufacturing and utility companies. General Electric is the only original company still included.

By 1928, the Dow comprised 30 stocks, which were divided into transportation, utility and industrial categories. Today, “industrial” includes anything not categorized as a transportation or utility stock. Not only have the selected stocks changed drastically during the past century, but so has the calculation method. Today, the DJIA is neither “industrial,” nor “average.”

Stock splits, spin-offs and dividends required adjustments to the formula. For example, three companies have share prices of $25, $50 and $75. The latter splits 3-for-1, so its shares now sell for $25. That moves the original average of $50 down to $33. Not only does this straight average not represent the true value of the group, especially for the one splitting its stock, but compared to the previous $50 average, it looks like a severe bear market has arrived.

An oversimplified explanation of the correction actually applied to this situation is to change the divisor. Instead of dividing by three, the divisor becomes whatever will bring the final average closest to the presplit number. If you find this kind of financial manipulation frustrating, remember the Dow is just a guideline to measure relative change, not the original true dollar average.

From the 40.94 on the first day, the Dow grew to 2,000 in 1987, hit 3,000 during the 1993 bull market and reached 8,000 in 1997. If you blinked, you missed the 1999 high of 11,000. During the recent bear market, you may have put your cash under the mattress and decided the market wasn’t stable enough to risk your nest egg in.

Though selection meetings are secretive, the Dow 30 has undergone remarkably few changes. In 1991, entertainment company Disney replaced USX. Hewlett-Packard, Johnson & Johnson, Citigroup and Wal-Mart were added in 1997, and Woolworth, Westinghouse, Texaco and Bethlehem Steel were out. Two years later, Microsoft, Intel, Home Depot and SBC replaced Sears, Union Carbide, Goodyear and Chevron.

Even the blue chips must continue to earn their place, as IBM found out when AT&T replaced it in 1939. It took IBM 40 years to get back in. The rest of the current list includes Alcoa, Altria Group, American Express, AIG, Boeing, Caterpillar, Coca-Cola, DuPont, Exxon Mobil, General Motors, Honeywell, JP Morgan Chase, McDonald’s, Merck & Co., 3M, Pfizer, Proctor & Gamble, United Technologies and Verizon.

The DJIA is not the only index, and others such as the Standard & Poor’s 500 and 100, NYSE 1500, and NASDAQ Composite are often considered more accurate. Whether indexes are “weighted” (price ¥ outstanding shares) or “unweighted” like the Dow, they all tend to move in concert. And one very successful formula for long-term market investment is still based on buying the five top-performing Dow stocks and recalculating annually. With the confusing array of choices and crackpot schemes available today, it’s probably as sensible an investment method as any other. Good luck. EC

NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at bigpeng@sbcglobal.net.

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