Category: Stocks

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

I’m back after a fun filled fabulous family vacation. (That’s for all of you who enjoy alliteration!) Let’s just jump into it.

Let’s assume you want to get into individual stock buying yourself either without a financial advisor or on the side of your financial advisor. Also (and always a good idea), you could just want to check the stocks your advisor has selected for your portfolio.

Let’s start with the basics.

My bias: When I look at a stock that I am mulling over, I start with Yahoo Finance. It’s concise, easy to read, readily accessible, and has the basic statistics needed for at a minimum first blush impression of the equity.

Most importantly, you can’t beat the price point.

It’s absolutely free for life!

There are many many other stock research sites you can use and some will convince they are the best and even try to seduce with a freemium model where if you just only spend a few measly dollars a month, even more information like “quantum data” or some such thing will be unleashed for just smart people like you.

Here is how Yahoo Finance is set up for individual stocks.(I’ll use Microsoft [MSFT] as an example though this could be any stock.)

 

 

Sarcastic Reader: That’s as we say in the biz…a shit ton of numbers…

Dr. Scared: This is it! This is how they screw you!!

Dr. Unwise: Exactly what business are you in that a “shit ton” is actually a unit of measure?

PWT: Uh…guys…FOCUS!

One by one, let’s discuss the above statistics.

The company name along with its stock symbol is listed. The stock exchange where this stock is traded is also listed as you can see in this case is our old friend, the NASDAQ,

It also is noted that the prices you see is in US currency.

The current price is pretty obvious (I hope) with how much it went up (YAY!) or how much it went down (Boo!) as well as the percent increase (or decrease) corresponding to the number of dollars and cents the stock moved.

Believe it or not, there is after hours trading (but not for mere mortals like you and me) that causes (generally speaking) small fluctuations and a difference between what the stock in question closed at and what price it will open at the following morning. Along with this again is both the percent increase (or decrease) corresponding to the number of dollars and cents the stock moved.

Previous Close: This is what price the stock closed at just before trading started today (ie, the day you are looking at the stock’s info)

Open: This is what the stock price is at the open of the trading day which can be quite different than what the closing price was depending on what happened between those points in time Remember that any event in the world at any time may affect a company’s stock—a scarcity of a needed mineral, a civil war, a strike starting at midnight after failed last minute negotiations, etc, etc.

Bid: The highest price that buyers of the stock are willing to pay for the stock

Ask: The price at which sellers of the stock are willing to sell it at

Day’s Range: Easy peasy lemon squeezy. This is the top price of the day along with the lowest stock price of the day which just means the range of prices that you could possibly have purchased or sold at. Realize that the closing price or opening price does not have to be either the top or bottom price of this range, just somewhere within this range.

52 week Range: Just as easy as the above. This is the lowest stock price and the highest stock price over the past year (ie, 52 weeks) to give you an idea of where the current stock price is relative to its (fairly recent) highs and lows

Volume: the number of shares traded during a given period of time (usually in a day if not stated differently otherwise) Volume typically does not affect stock price directly. However, a  very lightly traded stock (not likely any companies you have heard of and not any you would invest in until you have a critical mass of core holdings already and become a more savvy [and bolder] investor) may fluctuate significantly with an unusually high volume of trading. Also, if you see volume change significantly (higher or lower) for any stock, it may be indicating something about the company that should you pay attention. Stop looking at the key statistics of the stock and just put the company’s name into a search engine and see what news is out there about the company. ALWAYS REMEMBER: YOU’RE INVESTING IN COMPANIES, NOT JUST STOCKS.  

Average Volume: the number of shares traded in any given time period divided by that unit of time which can be recorded as daily, weekly, etc though it is often daily and in some stock sites it is then denoted as “Average Daily Trading Volume (ADTV)”

Market Capitalization: the stock price times the number of shares available for sale (ie, the number of outstanding shares) This can be misleading in terms of saying this is how much a company is worth given the fact that it doesn’t account how much debt the company may be carrying and the fact that it also doesn’t account for all the shares the company doesn’t put out for public sale among many other factors not to be discussed here

Beta: a stock’s sensitivity to the overall market

A beta of 1.0 means the stock moves (up or down) in perfect alignment with the overall market whereas a higher one means it moves higher or lower than the market’s same direction. For example, a beta of 1.10 means that this particular stock will move (up or down) 10% greater than the overall market does. A lower beta means that the stock in question will not move (up or down) as readily as the overall market does. Ideally, your stock has a beta of 1.0 since it is predictable relative to the market. If you have a high beta stock and the market has a downturn (and it will happen as sure night follows day), then your stock will likely get crushed.

(For you sadists who need to know how beta is calculated [no one is talking to you Dr. Scared or Sarcastic Reader], this is how it works in a thumbnail sketch. Believe it or not, the company’s monthly earnings over the past five months versus the returns from a major index {usually the S&P 500 which is serving as the surrogate of the overall market} who then undergo a statistical regression analyses [don’t ask me details people, I’m no mathmagician] and, voila, your greatly desired beta pops out.

Now imagine doing that for every publicly traded company every month.   

PE Ratio (TTM): the current share price divided by the EPS (earnings per share) This is a way to figure out the pricing of a stock relative to the overall market  and also other companies’ stocks especially if in the same sector (eg, comparing two tech companies or even more relevant [since tech companies are widely diverse—Google vs Netflix anyone?] two car companies). TTM=twelve trailing months—all numbers are based on what the company has done over the 12 months prior to the time you’re viewing these statistics.

EPS (TTM): Earnings per share The company’s earnings over the past 12 months divided by the number of shares of the company’s stock available for trading (AKA outstanding shares)

TTM=twelve trailing months—all numbers are based on what the company has done over the 12 months prior to the time you’re viewing these statistics

Earnings Date: The date at which the earnings of the company in question are publicly revealed This is done quarterly at least and can significantly change a stock’s price. People have bribed their way into getting that data early and invest accordingly—and then go to jail for insider trading

Forward Dividend & Yield: Forward dividends are exactly what they sound like—payments that are expected to be paid out in the future Trailing dividends are the ones that have already been paid and can be cataloged given that they have already been paid and are well known. There’s no speculation in trailing dividends, just forward ones. Estimating forward dividends is an art, not a science. If you have a company with stable dividend payments without any fluctuation for years or even decades, then the forward dividend estimation is easy. However, that’s rarely the case and then you need to look at the forward dividends with a skeptical eye. In either case, all dividend calculations are based off a time period of 12 months.

Dividend rate is the total amount of dividend payments paid over 12 months (forward or trailing). Dividing this dividend rate by the price of the stock and then multiplying that by 100 is the dividend yield. Think of the dividend yield this way: For every $100 invested in the stock in question, the dividend yield will tell you how much money will get paid out to you each year. (For example, a dividend yield of 3.35% will mean you as an investor will get $3.35 for every 100 dollars invested in that stock for that year.)

Ex Dividend Date: The date by which an investor will not get the next dividend Buy before this date and you will own the stock as short as possible to still get the dividend. If you’re going to buy a dividend paying stock anyway, the least you can do is buy it so you get your first dividend ASAP which makes a giant difference over the next 20-25 years.

1 Y Target Est.:To quote Yahoo Finance itself, “The 1-year target price estimate represents the median target price as forecast by analysts covering the stock. Data is provided by Thomson Reuters. More detailed target estimate data can be found by clicking a company’s “research” link.” In a practical sense, this is largely worthless given the fact it is updated only every 6 months or so.

Here are a few more statistics that Yahoo Finance doesn’t have featured prominently, but that other stock websites do.

Sales short:the total number of shares that are being sold short (ie, shares that are borrowed with the hopes that the company’s stock will go down in price) This gives you an idea of how some large experienced or even institutional investors view the stock if there is a high number of “shorts” betting against the stock. They may be wrong, but it should be heeded when many people are betting against the stock. What do they know that you don’t? It should give you pause as to why so many people are betting against it and why.

Short Interest: percent of outstanding shares that are being sold short In other words, of all the shares that are available for public sale, how many are betting that the stock will be going up versus how many are betting that the stock will be going down. It’s a general (though only one) indicator of investor sentiment which alone can drag down or elevate stock prices.

Ok….tons of info thrown out at you in one not-so-little blog post. Now that we’ve learned how to read through key statistics of a company’s stock, we can build on that next time.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

 

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

Preferred Stock

OK, people.

Confession time.

I made a massive mistake and am now correcting the error of my ways. While going over the basics of stocks, I somehow ignored/forgot the ins and outs of preferred stock.

PWT: Physician, Wealth Thyself to the rescue!!!

SR: What a dork…

Preferred stock lies somewhere between common stock (I know. Common…it makes you sound like a peasant…and this whole time you thought you were a budding tycoon…Damn!) and bonds in terms of what you are owed by the company and what you owe the company or are restricted doing. As the owner of preferred stock, once the company is in bankruptcy and has to liquidate its assets, it cashes out to everyone it owes money to including bond holders and then owners of preferred stock and then finally common stock owners…if anything at all is left over…which there never is.

Generally speaking, preferred stock have dividends and those dividends are paid out as a higher priority than those of common stocks. Even when the company in question is cutting or suspending dividends for common stock, it will pay out the dividends for preferred stock. However, if the company falls into such a bad cash flow situation that all dividends are suspended, eventually even the dividends of some types of preferred stocks can and will be stopped (whereas others cannot such as cumulative preferred stock—more on this later).

Preferred stocks are actually rated by credit agencies similar to bonds, but they are almost always rated lower than the best bonds because bond holders are creditors (ie, the bank for the company, remember?) and the company owes them above all others.

There are many types of preferred stocks which you can learn about on your own if you’d like, but I would not be a regular investor in them unless you have been a stock investor for years and really understand the ups and downs of stock investing OR have a financial advisor that is doing so for you. Even then, your financial advisor should be able to explain to you why they are putting your hard earned money into this preferred stock rather the common stock of the same company or any other investment. If this isn’t the case, you should either ask or not be invested in the preferred stock in the first place.

As a preferred stock holder, you have no voting rights in the operations of the company which is OK for virtually all retail investors (regular Joe and Jill investors like you and me), but it does need to be noted.

There are multiple reasons a company may issue preferred stock, but on the retail investor side, it’s essentially one line of thinking that leads you to buy preferred stock. You want a large, well established company that issues preferred stock with a high dividend which is well protected. Think of something on the order of a bond, but that pays a higher dividend that a bond does in its yield (generally speaking) and doesn’t lock you in for multiple years necessarily.

Here is a quick rundown of the pros and cons of owning a preferred stock.

Pros of Preferred Stock:

1. Higher fixed-income payments than bonds (usually) or common stock
2. Lower investment per share compared to bonds
3. Priority over common stocks for dividend payments and liquidation proceeds
4. Greater price stability than common stocks typically
5. Greater liquidity than corporate bonds of similar quality

Cons of Preferred Stock:

1. Callability (Depending on the kind of preferred stock and/or the terms attached to it, the issuing corporation can expire the preferred stock like a bond (remember?) depending on the needs of the corporation at any given time.
2. Lack of specific maturity date makes recovery of invested principal uncertain
3. Limited appreciation potential (You’re making money on the dividends typically and not the share price of the preferred stock itself.)
4. Interest rate sensitivity (Yes, interest rates will fluctuate and they can in turn affect the dividend rates on your preferred stock. As it becomes more expensive for the corporation to borrow money, then it will pinch down on money it has already borrowed from others (ie, you) when and where it can (such as it can with preferred stock and some types of bonds).
5. Lack of voting rights (if this matters to you)

Due to its fixed higher dividend rate(s), preferred stock has become more popular over the years and especially so over the past decade. Ten years ago, in the first quarter of 2008, the entire preferred stock market was valued at approximately $100 billion which seems staggering except when compared to other securities. At that time, the common stock and funds total market value was $9.5 trillion (9500% more than that of preferred stock) and the total value of the bond market then was over $4 trillion (4000% more than that of preferred stock). The increase in the preferred stock market has been steady as it was $241 billion by mid 2015 and $34.1 billion of new preferred stock was issued in 2016 alone. However, again, it was dwarfed by the $22.71 trillion total value of all available stocks/funds/bonds at that time. In fact, just three years ago, the total preferred stock market was only 3% of the total value of just the CORPORATE bond market alone (exclusive of the municipal and federal bond markets).   

One last thing of note for preferred stocks is how they are listed. Common stocks are just listed with the name of the company and what is known as the stock symbol or ticker symbol (such as Apple with AAPL or McDonald’s with MCD).

Preferred stocks however are listed in their own language such as the following:

Ashford Hospitality Trust Inc 8.45% Cum Pfd Ser D

SR: What in the name of all that holy is that abomination of a name mean?

Ashford Hospitality Trust Inc (Incorporated) is the name of the corporation issuing the preferred stock.

The 8.45% is the dividend yield that can reliably be expected as long the preferred stock is owned.

The Cum refers to…

SR: Yeah, hold it right there, Professor, We all know what that means…

PWT: Uh, yeah. ANYWAY…

That uh…abbreviated designation refers to the fact that this preferred stock is cumulative (see the links above for the most common types of preferred stock) meaning that if for any reason that the dividend is not paid at the expected time, then it is promised to be paid later (ie, the dividends/payments will accumulate).

The “Pfd” simply refers to the fact that it is preferred stock.

The “Ser D” means Series D refers to the fact that it is the fourth time preferred stock has been issued by this company. (Since D is the fourth letter of the alphabet, it indicates that it is the fourth offering of the preferred stock issued by this particular corporation.)

Dr. Know It All: Exactly how stupid do you think we are?

SR: Wait! Don’t answer that.

The way preferred stock is listed is as variable as the numbers and types of preferred stock.

Personally, I like it that way. It’s not meant to be confusing, but certainly can be. Consider it like a check against yourself or a speed bump to slow down you deploying your hard earned capital into the scary world. If you can’t understand every single bit of the listing of the preferred stock on your own (no cheating on the Internet!), then you shouldn’t invest in it. That’s a pretty good rule of thumb I would say.

I think this is a pretty good stopping point.

My apologies to all of you for skipping over this earlier, but maybe it was a good thing since this made for a more bite sized post to digest. (Self rationalization is also a good thing.)

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your family, friends, and colleagues.

Talk to you soon.

Until next time…

 

Never forget these two axioms:

 

Money frees us, but its pursuit may enslave us.

It’s not about how much you have at the end; it’s how much you could have made.

 

Stock Exchanges

 

Not to get too big of a head, but let me quote myself from an earlier post…

 

“There’s a marketplace where people go to buy stocks just like you (or people you know because I’ve actually never done this even once in my life) buy produce at a farmer’s market.  This marketplace is called an ‘exchange’.”

 

Realize that not only stocks, but bonds and other securities (i.e., any tradeable financial instrument) can be bought and sold (i.e., traded) in what are commonly called “stock exchanges” or just “exchanges”, but clearly involve far more than stocks alone.

 

There are 18 stock exchanges in the world that have a market capitalization (i.e., all the combined value of all the stocks of all the companies in said exchange) of over $ 1 trillion (US) each. They are sometimes referred to as the “$1 Trillion Club”. These 18 exchanges accounted for ~90% of global market capitalization in 2015.

The below are the top twenty exchanges in the world ranked by market capitalization.

(The below are the name of the exchange, country, city, and market capitalization in millions of US dollars as of October 2017.)

 

1.)    New York Stock Exchange    United States    New York    21,377

2.)    NASDAQ    United States    New York    9,585

3.)    Japan Exchange Group    Japan    Tokyo    5,974

4.)    Shanghai Stock Exchange    China    Shanghai    5,043

5.)    Euronext European Union         Amsterdam/Brussels/Lisbon/London/Paris 4,388

6.)  London Stock Exchange    United Kingdom London    4,297

7.)    Hong Kong Stock Exchange    Hong Kong 4,135

8.)    Shenzhen Stock Exchange    China    Shenzhen    3,688

9.)    TMX Group    Canada    Toronto    2,360

10.)    National Stock Exchange of India India    Mumbai    2,194

11.)    Deutsche Börse    Germany    Frankfurt    2,181

12.)    Bombay Stock Exchange    India Mumbai 2,175

13.)    Korea Exchange    South Korea    Seoul    1,683

14.)    SIX Swiss Exchange      Switzerland    Zurich    1,649

15.)    Nasdaq Nordic    Northern Europe, Armenia    Stockholm    1,561

16.)    Australian Securities Exchange    Australia    Sydney    1,428

17.)    JSE Limited      South Africa    Johannesburg    1,129

18.)    Taiwan Stock Exchange    Taiwan    Taipei    1,068

19.)    BM&F Bovespa  Brazil    São Paulo    935

20.)    BME Spanish Exchanges  Spain Madrid    896

 

The New York Stock Exchange (NYSE)

 

New York, New York…The Big Daddy of Them All…Make It There and You’ll Make It Anywhere

 

The New York Stock Exchange (NYSE) is by far the largest of all the exchanges at over $21 trillion (roughly the value of the next four biggest exchanges in the world combined) with daily trading over $30 billion (often over $35-40 billion) and even a few days in 2017 near or above $100 billion just for that day.

There’s a reason for all this money floating around.

To be listed on the NYSE, a company must have issued at least one million shares of stock worth $100 million and must have earned more than $10 million over the last three years. The entry fee to the NYSE is up to $500,000-$75,000 with a yearly listing fee of up to $500,000 as well.

Yeah, your corner Gas-n-Sip isn’t going to cut it…unless it’s one of 400 locations.

The NYSE is open for trading Monday through Friday from 9:30 am – 4:00 pm EST, with the exception of holidays. So, putting in buy or sell orders after work means it will only be done the next trading day.

Believe it or not, the NYSE is a giant series of simultaneous auctions on all the stocks in the exchange where traders can trade stocks on behalf of investors. The traders who work for the NYSE literally huddle around the appropriate post where a specialist broker, who is employed by a NYSE member firm (ie, not an employee of the NYSE), acts as an auctioneer in an open air auction where buyers and sellers are brought together to execute transactions. If you see any movies like “Trading Places” where they show the trading floor of an exchange, it looks chaotic. And in the days of pen and paper, quite frankly, it was.

Of historical record, on September 25, 1995, NYSE member Michael Einersen, who designed and developed this system, executed 1000 shares of IBM through wireless hand-held computers (HHC) (it was his honor to do so since he designed and developed the system which allowed traders to both receive and execute trades electronically) ending a 203-year process of paper only transactions forever. Within two years, virtually all companies’ stocks could be traded electronically. Well over 90% of the trades at the NYSE are done electronically allowing for last minute, end of the day trades with nearly instantaneous execution.

Following the Black Monday market crash in 1987 (October 19, 1987, the largest one day DJIA percentage drop [22.6%, or 508 points at that time] in history occurred), the NYSE imposed brakes on trading to decrease volatility and hopefully end massive panic selling.

The NYSE has set the following three thresholds based on the average closing price of the S&P 500 (note that it’s the S&P 500 used for the benchmark and not the DJIA) for the preceding trading day.

They are the following:

Level 1: -7%

Level 2: -13%

Level 3: -20%

Therefore, if there is a level 1 or level 2 decline, there will be a 15 minute stoppage in trading (unless it occurs after 3:25 pm in which case no stoppage in trading occurs).

A Level 3 decline, on the other hand, triggers a suspension of trading being for the remainder of the day no matter when it occurs.

The NASDAQ (National Association of Securities Dealers Automated Quotations)

The NASDAQ is the world’s second largest stock exchange as noted above (pretty impressive since it only started in 1971) and, as mentioned before, it tends to be heavy in technology companies. Microsoft, Apple, Cisco, Oracle, Dell, Google, Amazon, Facebook, and Netflix (but no chill) all debuted on the NASDAQ. It is still the go to exchange for the emerging technology company to debut on.

(In contrast to the NYSE, to be listed on the NASDAQ a company must have issued at least 1.25 million shares of stock worth at least $70 million and must have earned more than $11 million over the last three years. Speaking of contrast…the entry fee to the NASDAQ is $50,000-$75,000 with a yearly listing fee of ~$27,500. It’s good business to have low entry fees for tech startups gone big who are low on cash—which is the whole reason the company is offering shares in the first place.)

Not surprisingly, the NASDAQ was the first exchange in the US to start trading online, highlighting Nasdaq-traded companies and closing each trade with the boastful claim (and not so subtle jab at the old, stodgy NYSE) that the NASDAQ was “the stock market for the next hundred years”.

As of June 2015, the NASDAQ has an average annualized growth rate of 9.24% since its opening in February 1971.

Since the end of the so called “Great Recession” in June 2009, it has increased by 18.29% on average per year.

The NASDAQ Composite Index has actually more than quadrupled since January 2009.

Again, this is not at all surprising given how many of the largest technology companies (most of which are listed on the NASDAQ) are doing in the last forty years and especially the last decade.

Just so you know, there is a third stock exchange (also in New York just so they’re not feeling left out) called the American Stock Exchange or AMEX where approximately 10% of all the securities in the US traded. So, though you may have never heard of it, this is no small, cheap, chump change operation.

Once a major competitor of the NYSE before the NASDAQ came along in 1971, the American Stock Exchange is now mostly known for trading in small cap stocks, options, and exchange traded funds. Actually, AMEX is where ETFs were first employed.

AMEX has the least strict listing requirements among the three top American exchanges, which consequently results in many small companies joining it rather than the other two.

If you haven’t heard of Peabody Energy, you probably haven’t heard of any of the other companies listed on the American Stock Exchange.

Back to the Big Two…

So both the NYSE and NASDAQ are US stock exchanges (the two largest in the world) that the vast majority of publicly traded US companies are listed on with different entry fees.

The NASDAQ is owned and run by a for profit company. The NYSE was a non-profit entity…until March 8, 2006 when the NYSE became a for profit company publicly traded…on the NYSE. (To blow your mind further, the NASDAQ trades…on…wait for it…yep, you guessed it…the NASDAQ.)

So what’s the difference between the two?

Two principal differences:

1.) The NYSE has its trading occur on an actual physical “trading floor” at 11 Wall Street NYC. The NASDAQ doesn’t have a physical location for trading, but rather is a telecommunications network upon which all their online trading occurs.

2.) As noted before, the NYSE is like the world’s largest auction house where thousands of auctions between buyers and sellers happen every trading day (i.e., an auction market—I know, I know, I used the word ‘auction’ three times in one sentence, but there is no good synonym for that word I will not mention again in this post.) In the NYSE, you’re buying essentially what someone else has just sold.

The NASDAQ, though, is what is known as a dealer’s market where both buyers and sellers conduct their desired business through a third party.

That’s really it as far as us retail investors are concerned.

One last thing…

ADRs

Dr. Unwise: Uh…what now?

Dr. Scared: This is it! This is how they screw you!! Money under the mattress is the only way to go!

PWT: Uh, yeah, anyway…

 

ADRs or American Depository Receipts is how a non-US company can be listed on a US stock exchange. Think about it for a second. How does a, say, company in the UK like BP (it is British Petroleum after all) which is already listed on the London exchange get listed in the US? Honestly, what company wouldn’t want to have access to all the money American investors, retail and institutional, (aka the US capital market) provide?

So, this is how BP pulls off the neat trick of being listed at home in London and again in New York.

Before 1927 when ADRs were first introduced, the only way an American could buy into a foreign company was to buy shares on a foreign exchange.

The problem with that is twofold:

1.) You’re at the mercy of regulations in whatever country your company of choice is from.

2.) Currency fluctuations and foreign taxes may wipe out your gains.

An ADR is a US bank issued certificate that represents a share or a number of shares (or even a fraction of a share) in a foreign company that is traded in a US exchange. (To be more precise, every ADR is issued by a US bank [known as the custodian bank] once the underlying shares of the foreign company are deposited in a bank of the same  country of the foreign company.)

They act, feel, and trade like any other shares of any other company. ADRs are bought, valued, and even pay dividends in US dollars.

Generally speaking, the ADR moves in parallel with the foreign stock in its home country (but adjusted for the ratio of ADRs to shares of the foreign company in question since they don’t have to be 1:1).

Of note, UK companies that set up ADRs generate a 1.5% “creation fee” that you get to pay for the privilege of buying the ADRs of said UK company.

Other than a few exceptions like the above, ADRs should be evaluated, treated, and traded like any other stock.

Whew!

Enough.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

 

Talk to you soon.

 

Never forget these two axioms:

 

Money frees us, but its pursuit may enslave us.

It’s not about how much you have at the end; it’s how much you could have made.

 

We’re going to take a break from asset classes for one post to talk about what indexes actually are.

 

Indexes

 

Let’s start with the biggies.

 

There’s the S&P 500, the Dow Jones Industrial Average (usually referred to as the “Dow Jones”), and the NASDAQ.

 

You hear these terms thrown around on the news, articles, etc. all the time with everyone expecting you to know and understand what all of this means.  You may know exactly what this all means; you may only know that these words are vaguely related to investing, but you’re not sure what any of these terms actually mean.

 

What’s what what? What? Huh?

 

Market Index

 

The S&P 500, NASDAQ, Dow Jones, Russell 2000, and Wilshire 5000 are all examples of a “market index.” An index provides a summary of an overall collection of stocks by tracking some of the top stocks within that market. They provide (or try to provide) a representative picture that shows the direction (up or down) of where the overall market is going.

 

Consider them like polls for an election—just taking a representative sample to demonstrate what a larger group is or will be doing.

 

Indexes definitely don’t track every single stock. Some indexes represent small, medium, and large companies while other indexes represent only the largest companies or only small companies.

 

Some indexes tend to track companies within a certain sector, like technology, but most are broader.

 

So what are the most popular market indexes?

 

The S&P 500

 

This index tracks 500 large U.S. companies across a wide span of industries and sectors.

 

The stocks in the S&P 500 represent roughly 70 percent of all the value of all the stocks that are publicly traded (i.e., market capitalization) even though there are over 17,000 traded stocks in the US alone (which tells you how massive and valuable these 500 companies—the ones most everyone has heard of; the Apples, Googles, Facebooks, Fords, and Microsofts of the world— and how tiny and cheap the other 17,000 companies are). (By the way, “S&P” stands for “Standard and Poor’s,” the name of a stock market research firm.)

 

Companies CAN be (and often are) listed in more than one index. Some of the largest companies within the S&P 500 are also in the Dow Jones Industrial Average.

 

When people talk about “the market”, as in “How did the market do today?” or “The market is on fire!“, they’re virtually always taking about/referring to the S&P 500 and its performance. The only other possibility is coming up next.

 

When trying to figure out how your stock, portfolio, or mutual fund/ETF is doing, you’ll be most often using the S&P 500 as your benchmark of comparison.

 

 

The Dow Jones Industrial Average (DJIA)

 

Cool (my idea of cool is probably waay different than yours) fact:

 

Charles Dow, the editor of the Wall Street Journal actually, created the first index more than a century ago. (The Jones in question is Edward Jones, a statistician and fellow journalist of Dow’s.) In 1896, Dow averaged the stock prices of the top 12 publicly traded companies in the US. (All he did was add their stock prices of the top 12 publicly traded companies in the US together and divided that total by 12, the number of stocks.)

By doing this, he found that he could trace the movement of the overall market, including the average movement of stocks that weren’t included in his index. Sure, some stocks move opposite of the index, but not by much (usually) and they were the exception. (You have to be spectacularly talented (and not in a great way) to lose money when the index in question is up and you have to be spectacularly talented (in a great way!) to make money when the index in question is down.

That’s far from how it’s done now.

The “Industrial” in the Dow Jones Industrial Average is largely historical referring back to the heavy industries of the early 20th century. Many of the modern 30 component companies (It’s now 30 companies in the Dow rather than the original 12 which is why you’ll hear about the “Dow 30” occasionally) have little or nothing to do with true industry or traditional manufacturing. It is also not only the largest (however that is defined) companies in the US on it necessarily any more. For example, Google and Facebook aren’t on the DJIA…at least for now.

Also, the average is what is known as price-weighted, and to compensate for the effects of stock splits and other adjustments, it is currently done as a scaled average.

Dr. Unwise: Um, what now?

Price weighted is easy to explain.

PWT: 30 companies=100% of the DJIA, right?

Dr. Scared: Yes!

PWT: Therefore, each company~3.3% of the DJIA, right?

Dr. Scared: Yes!

PWT: Wrong. 

Dr. Scared: Oh God, kill me now!

PWT: Relax. The DJIA just takes into account the stock price of each company. Therefore, a $100 stock will have ten times the influence on the DJIA as a $10 stock and 100 times more influence than a $1 stock. 

Dr. Unwise: Makes sense. That’s great. Easy to understand too. That’s it, right?

PWT: No, sadly, like they used to tell us in med school and training, that was the easy part. 

Dr. Scared: Oh God, kill me now!

Scaled average is a statistical method to even out disparate entities that are all under one umbrella.

In other words, the value of the Dow (i.e., the number that people are saying on the news when they say “The Dow closed at…. today” or “Today, the Dow reached an all time high of ….”) is no longer the actual average of the prices of its component stocks like when it first began, but rather the sum of the component prices divided by a divisor, which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index.

Whether one stock is spitting out quarterly dividends, another is splitting, and yet another is doing neither, the DJIA’s value reflects the sum of all these disparate company’s stocks. Otherwise, without the Dow divisor, dividends and, especially stock splits (remember, for example, if having 100 shares of a $100 stock for a total value of $10,000 is split 2:1, then you have 200 shares at $50 still valued at $10,000), would markedly alter the Dow’s reported number without actually changing its true value.

Currently the divisor is less than one, therefore the value of the DJIA is actually larger than the sum of the component prices.

SR: Hmm, sounds fishy. Like some real Wall street flim flam there. 

PWT: Not really. Not this time. But don’t worry. There’s plenty of flim flam going on in Wall

        Street and Washington—often one because of the other. This just isn’t it though. 

The Dow divisor has fluctuated significantly over the years. In 1928, it was 16.67. Since most big company actions (e.g., stock splits, spin offs, etc.) push the Dow divisor lower, it should be no surprise that the divisor is now microscopic compared to its 1928 value which it is.

Drum roll please…

The Dow divisor as of 12/18/17 (the day I’m writing this) is 0.14523396877348.

Unlike mathematicians, the Dow Jones clearly doesn’t believe in the rule of significant digits given it has a divisor that is currently 14 digits beyond the decimal point.

SR: Jones! Pffft…Some statistician he is!

The Dow Jones Industrial Average (DJIA or the Dow Jones or just “the Dow”) was comprised of the 30 largest U.S. companies. (This isn’t true per se now depending on how you define company size—number of employees, sales, revenue, market capitalization, etc.)

This means the DJIA is constantly shuffling companies in and out as their values rise and fall. They drop and add new companies every so often (every 2-3 years as of late). The components of the DJIA have changed 51 times since its beginning in May 26, 1896.

Only one company on the original Dow Jones list of companies in 1896 still exists on today’s Dow Jones. Any guesses?*

Just for kicks, here are the current Dow 30 (another name used for the DJIA) companies:

3M Company

Caterpillar Inc.

Nike, Inc.

American Express Company

The Goldman Sachs Group, Inc.

Pfizer Inc.

Apple Inc. (added in March 2015 replacing AT&T which was dropped then)

The Home Depot, Inc.

The Procter & Gamble Company

The Boeing Company

Intel Corporation

The Travelers Companies, Inc.

General Electric Company

International Business Machines Corporation AKA IBM

UnitedHealth Group Incorporated

Chevron Corporation

Johnson & Johnson

United Technologies Corporation

Cisco Systems, Inc.

JPMorgan Chase & Co.

Verizon Communications Inc.

The Coca-Cola Company

McDonald’s Corporation

Visa Inc.

E.I. du Pont de Nemours & Company  AKA Dupont

Merck & Co., Inc.

Wal-Mart Stores, Inc.

Exxon Mobil Corporation

Microsoft Corporation

The Walt Disney Company

 

The DJIA along with the S&P 500 are widely accepted as the leading indicators of the health of the stock market. If someone is talking about “the market”, the DJIA or S&P 500 is what they’re likely using as their measuring stick to make any remarks or generalizations about “the market.”

The Wilshire 5000

A lesser known, but still important, index represents up to 5,000 companies of all shapes and sizes, from gigantic corporations to the smallest of small companies. (In industry terminology, these are known as “large cap,” “mid-cap” and “small-cap.”)

The Wilshire 5000 is often called the “total market index.” Despite how representative this index is of the entire stock market, it oddly isn’t nearly as popular or as followed as the DJIA and S&P 500 which I’ve never quite understood. 

 

The Russell 2000

The Dow Jones focuses on large companies, but the Russell 2000 does the opposite: it follows only the tiniest companies. This index tracks 2,000 of the smallest corporations in the stock market.

If you’re either brain addled or a statistician obsessed with number needed to treat and you think that 2,000 companies is too small of a sample size, and you’re seeking for a larger, more representative snapshot of how small-cap companies are faring, you’re in luck. You can gaze upon the Russell 3000, the sister index to the Russell 2000.

The NASDAQ (the acronym for the National Association of Securities Dealers Automated Quotations)

This is one of the three big indexes, but I saved it for last as it can get a little confusing.

“NASDAQ” refers to both an index and a trading exchange.

Dr. Unwise: Uh…What now?

Dr. Scared: Oh God, kill me now!

OK, let’s back up and get a little back story here.

There’s a marketplace where people go to buy stocks just like you (or people you know because I’ve actually never done this even once in my life) buy produce at a farmer’s market.  This marketplace is called an “exchange.” The most famous one in the world that all the movies and news programs show is the New York Stock Exchange (NYSE). There’s another famous one also in New York City (they’re actually only 7 minutes apart and represent over $30 trillion—that’s Trillion with a capital T or $30,000 billion or $30 million million if that is even comprehensible) called the Nasdaq Exchange.

Stocks that are traded on the Nasdaq Exchange tend to be tech companies, like Apple Amazon, Facebook, and Google, but you don’t have to be a tech company to be on it (Starbucks is traded in the Nasdaq as is Steve Madden, the shoe company, for example) nor all tech companies traded in the Nasdaq exchange. Twitter, for example, is traded on the NYSE.

SR: Ha! Twitter is a terrible example. It may not even be around by the time you post this to the World Wide Web!

Of course, companies on the Nasdaq or NYSE don’t have to be as huge as Apple, Facebook, or Google.  In fact, most of the companies listed in either exchange are much, much smaller.

You’ve likely never heard as many sell only to other businesses and not consumers like you and me.

The Nasdaq is just disproportionately heavy in tech stocks and will surge up or bounce down when something (good or bad) happens in the tech world.

The Nasdaq market index, which is known as the “Nasdaq Composite” or just the “Nasdaq”, tracks the roughly 3,000 companies that are traded on the Nasdaq Exchange by having 100 companies (mostly, but not all tech) in it to mimic what all of them are doing on any given hour of any trading day. (Very, very clever, stock people.)

This is peculiarly unique because no other exchange has its own popular index. The news doesn’t reel off closing highs or lows of the day from the “New York Stock Exchange Composite” mostly because it doesn’t exist. #fakenews

(Of note, this is a market capitalization weight based index which means that 100 companies aren’t each 1% of the index, but rather the bigger they are, the more percent of the index they are. These massive (almost always) tech companies have an outsized influence on the Nasdaq Composite. For example, if Google, Facebook, Apple, Amazon, and Netflix zoom up one day while most of the other 100 companies in the Nasdaq Composite edge down, then guess what? The index still moves up because the big boys have spoken. As companies decrease or increase in value, their share of the index and influence on it will fluctuate accordingly.)

The Nasdaq Composite has grown popular because it’s commonly accepted as a shortcut to understanding how the biggest tech-sector and some other innovative companies – both big and small – are performing financially. And since tech is the tail that wags the dog, everyone wants to hear what the NASDAQ is up to.

Much more on stock exchanges in a future post.

I think we’ve all had enough for one post.

Sorry for going suuuper long on this one, but there was a lot of super important stuff that was all interrelated here that I thought was best to go over all at once.

Sorry if you disagree.

Read it again or as many times as you need to or in bits and pieces. You’re all smart. You know how you best learn, so go and ahead and do it your way at your pace.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Talk to you soon.

*General Electric is the only company that survived all 121 years on the DJIA list.

Well, not exactly.

GE was removed from the DJIA in September 1897 and came back in November 1907. It’s been on the DJIA since then.

And for you history buffs out there, below are the original dozen companies in the 1896 Dow Jones Industrial Average.

 

1.) American Cotton Oil Company, a predecessor company to Bestfoods which is now part of Unilever.

2.) American Sugar Company which became Domino Sugar in 1900 which is now Domino Foods, Inc.

3.) American Tobacco Company which is now broken up in a 1911 antitrust action.

4.) Chicago Gas Company which was bought by Peoples Gas Light in 1897 which has since become a subsidiary of Integrys Energy Group.

5.) Distilling & Cattle Feeding Company is now Millennium Chemicals

6.) Laclede Gas Company is still in operation as Spire Inc., but was the first company permanently removed from the Dow Jones Industrial Average all the way back in 1899

7.) National Lead Company, now NL Industries, which was removed from the Dow Jones Industrial Average twenty years after its inception in 1916.

8.) North American Company (boffo marketing division, guys), a holding company for electric utilities, was broken up by the U.S. Securities and Exchange Commission (SEC) in 1946.

9.) Tennessee Coal, Iron and Railroad Company was bought by U.S. Steel in 1907 which was removed from the Dow Jones Industrial Average in 1991—pretty great run!

10.) U.S. Leather Company was dissolved in 1952 because of jerks like you with your faux leather belts and whatnot (especially the whatnot)

11.) United States Rubber Company which changed its name to Uniroyal in 1961, then merged with B.F. Goodrich (a privately held company—i.e., a company that you can’t buy stock in) in 1986 which was then bought out by Michelin in 1990.

12.) Good ol’ GE as previously mentioned