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Stock Indexes

STOCK INDEXES

An understanding of the basic characteristics of the different kinds of stocks will be helpful in considering the information in this article. An investor's most important tool is information: information about stock prices, movement in the market, and business trends. Without sound information, investment decisions are pure guesswork. The first place to look for information about any stock is the financial pages of a newspaper, and the best place to start is with the columns listing the current stock prices on one or more of the major organized exchanges. Figure 1 shows a typical listing for a stock traded on one of the major exchanges. The following list explains the information and what it means for prospective investors:

SAMPLE STOCK LISTING

  1. High and low. These are the highest and lowest prices paid for the stock during the previous fifty-two weeks. This item shows that the highest price paid for this stock during the previous period was $44 per share; the lowest price, $16 per share.
  2. Stock. Stocks are listed alphabetically by an abbreviated form of the corporate name, in this sample, JLJ.
  3. Dividend (Div). The rate of annual dividend is shown; it is generally an estimate based on the previous quarterly or semiannual payment. This item shows that JLJ is paying an annual dividend of $2.50 per share, or about 7 percent yield.
  4. Price/Earnings (P/E) ratio. This is the ratio of the market price of the stock to the annual earnings of the company per share of stock. It is an important indicator of corporate success and investor confidence and cannot be calculated from the information given here as other data are needed to do so.
  5. Shares traded. This is the number of shares sold for the day, expressed in hundreds. In the example shown, 3,300 shares of JLJ stock were traded. The figure does not include odd-lot sales. Note: If the number in this column is preceded by a "z," it signifies the actual number of shares traded, not hundreds.
  6. High and low. These are the highest and lowest prices paid for JLJ stock during the trading session (that is, the business day). The highest price paid for JLJ stock was $35.25 per share; the lowest price, $34 per share.
  7. Closing price (Last). The final price of JLJ stock for the day. In this case, it was $35 per share.
  8. Change. The difference between the closing price of the stock for this session and the closing price for the previous close; yesterday's closing price would have been $34.50 ($35.00 minus $0.50).

Understanding the details of a particular stock is basic to finding value in a stock market index which reflects a critical characteristicstatistically determinedabout a group of stocks. What follows is a general introduction to such indexes.

USEFULNESS OF STOCK MARKET INDEXES

The expectations of future growth and profit are captured through computations that are called market indexes. Such indexes provide, in essence, summaries of expectations. There are indexes that cut across industries; there are indexes that deal with one industry only. Indexes include varying numbers of stocks. Additionally, indexes are based on a variety of assumptions about the factors that influence expectations. Factors that might be used in several indexes may be given different weights in each index. Many market indexes will, at times, provide the same, or similar, assessments. Nevertheless, there is considerable difference in the performance of indexes in the long run. The stocks, divisors, and weighting selected for an index lead to long-run difference.

SOME POPULAR STOCK MARKET INDEXES

There are thousands of stock market indexes. Much information is available through accessing Web sites of exchanges and other organizations, such as Dow Jones and Russell Group, that have developed indexes. Details of the assumptions and stocks included are readily provided in materials accessible at Web sites. Some stock exchanges provide custom-designed stock market indexes. There are such indexes in many countries. Some of the most popular U.S. indexes in (alphabetical order) are:

  • American Stock Exchange (AMEX) composite index
  • Dow Jones Industrial Average (DJIA) index
  • NASDAQ composite index
  • NASDAQ 100 index
  • New York Stock Exchange (NYSE) composite index
  • Russell 3000 value index
  • Standard & Poor's (S&P) 500 index

Three of the most widely quoted stock market indexes and the types of stocks they include are briefly discussed here.

Sample stock listing
High Low Stock Div P/E 100S High Low Last Change
(1) (1) (2) (3) (4) (5) (6) (6) (7) (8)
44 16 JLJ 2.50 9 33 35.25 34 35 .50

Stocks that make up the Dow Jones Industrial Average as of 2005
3M (MMM) Exxon (XON) McDonald's (MCD)
Alcoa (AA) General Electric (GE) Merck (MRK)
Altria Group (MO) General Motors (GM) Microsoft (MSFT)
American Express (AXP) Hewlett-Packard (HWP) Pfizer (PFE)
American Int. Group (AIG) Home Depot (HD) Proctor & Gamble (PG)
Boeing (BA) Honeywell Int. (HON) SBC Communications (SBC)
Caterpillar (CAT) Intel (INTC) United Technologies (UTX)
Citigroup (C) International Business Machines (IBM) Verizon Communications (VZ)
Coca-Cola (KO) Johnson & Johnson (JNJ) Wal-Mart (WMT)
Du Pont (DD) JP Morgan Chase (JPM) Walt Disney (DIS)

THE DOW JONES INDUSTRIAL AVERAGE

Charles H. Dow (18511902) introduced the Dow Jones Industrial Average (DJIA) in 1896 when the market was not considered a respectable venture because of unscrupulous dealers, massive speculation, and the lack of information. His average brought about change at a time when people found it quite difficult to understand the ups and downs of fractionalized points. It is called an average because it originally was computed by taking the stock prices, adding them together, and dividing them by the number of stocks. The first figure came out on May 26, 1896, with an average of 40.94. Dow defended his average by comparing it to the placement of sticks in the sand on the beach. His concept was to determine, after each wave, whether the tide was coming in or receding. If the average of his stocks increased progressively, then he was able to call the period a "bull market." If the average dropped lower, then a "bear market" had taken hold.

The DJIA provides a comparison of industrial stocks to the direction of the average. In attempts to gauge or predict large-scale trends in stock market values, the DJIA is most often cited. The term industrial is a bit misleading. In the late nineteenth century, railroads and steel companies were the important corporations. In the twenty-first century, they do not represent any great hold on the DJIA.

The DJIA is the most frequently mentioned of four Dow Jones averages (covering industrial stocks, transportation stocks, utility stocks, and a composite average); it is a barometer of stock market trends based on the stock prices of thirty large U.S. corporations listed on the NYSE. Every day, the fluctuations in the prices of these stocks are combined by adding up the prices of the thirty stocks and dividing the result by the designated factor used to compensate for complicating situations, such as stock splits, spin-offs, and periodic substitutions in the list of stocks used.

The current divisor is published every business day. Over the history of the average, the divisor has been changed many times, mostly downward. This explains why the average can be reported as, for example, 10,000, although no single stock in the average approaches that price level. In 2006, a $1 rise in the price of a component stock would raise the DJIA roughly five points, assuming prices of the other twenty-nine stocks were unchanged. The thirty stocks and their symbols that made up the DJIA during 2005 are shown in Figure 2.

THE STANDARD & POOR'S 500

The Standard & Poor's (S&P) 500 index was created (in its present mode) in 1958 in order to make indexes more popular with the investing public. Rather than keeping its previous index, made up of ninety stocks, it moved to a much broader scale of 500 stocks, making it the S&P 500. In its continuous review, the selection committee replaces about thirty companies annually. The reason for a company's elimination might be its own downsizing (so it can no longer be considered a large-cap [capitalization] stock) or its acquisition by or merger with a different type of company not represented in the S&P.

The reported number (factor) that one sees in the daily paper or hears about on the financial news report, along with the Dow and the NASDAQ, is determined by the price of the 500 stocks in the S&P index. It is also important to mention that the S&P is market-weighted. This is done so that no single company, or small group of companies, will dominate the index or influence its calculations. Market weighting is determined by taking the number of shares of the outstanding stock of a company and multiplying it by its price. This creates a market situation in which no one company's performance can drastically change the overall performance of this index. The DJIA is not calculated in this manner, creating the possibility that the performance of a single stock in the Dow could change the value of the entire index on any given day.

Also, consider the number of businesses involved in the S&P index. With 500 stocks market-weighted, this index becomes a good indicator of market movements because it mirrors the combined knowledge of thousands of analysts and investors who, through their sales and purchases of stocks, determine the market value of the shares of stocks in the index.

THE NASDAQ COMPOSITE

The NASDAQ (originally known as the National Association of Securities Dealers Automated Quotations) was created in 1971 to compete with the S&P 500 and to measure the entire range of the market. With a great proportion of its companies in the high-tech field, however, the NASDAQ is much more volatile than the stock market in general and the Dow and the S&P in particular. The NASDAQ is not involved only in high-tech stocks; the index, however, comprises eight industry subindexes: banking, biotechnology, computers, finance, industrials, insurance, telecommunications, and transportation.

The NASDAQ has been called the "index of the new economy," as compared to the "old economy" of the Dow. This composite index includes 5,500 companies and, like the S&P, is market-weighted, thus providing more meaningful numbers. The index's composite figure is computed by measuring the market value of all common stocks listed on the NASDAQ. Any change in any security in any direction will cause the index to change in that direction, but only in proportion to its market value (the last transaction price multiplied by the total shares outstanding). In 1985 NASDAQ introduced the NASDAQ-100 index, which is made up of the largest and most active nonfinancial domestic and international issues on the NASDAQ stock market based on market capitalization.

It is true that there is no way to tell where the market will be a year or two from now, but by keeping informed and using indexes as a guide, investors stand a better chance in the roller-coaster market that has been experienced.

see also Investments ; Stocks

bibliography

Davis, Ned (2005). Markets in motion. New York: Wiley.

Ingebretsen, Mark (2002). NASDAQ: A history of the market that changed the world. New York: Crown.

Little, Jeffrey B., and Rhodes, Lucien (2004). Understanding Wall Street (4th ed.). New York: McGraw-Hill.

Weiner, Eric J. (2005). What goes up: The uncensored history of modern Wall Street as told by the bankers, brokers, CEOs, and scoundrels who made it happen. New York: Little, Brown.

Joel Lerner

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