The stock market is moderately higher this month. The Dow is up about 650 dollars or 2.5%. Other indexes are up different amounts, some more and some less. More on this topic in a moment as we go over a few definitions.
A stock is an ownership stake in a company. If a company was split into 100 shares of stock and you bought 1 share, then you own 1% of the company. The value of that share on the stock market is based on how much investors think that company will be worth in the future.
Investors essentially take all the money that they think the company will make in the future and discount that value to the present (time value of money). If the value they calculate is larger than the current cost of the stock then then they will bid the price of the stock up by buying it. If the value they calculate is smaller than the current cost of the stock then then they will drive the price of the stock down by selling it.
The price is NOT based on the current economy. The economy right now sucks. The market is doing quite nicely. The reason is that the price is a prediction of next year’s profits.
The stock market is the aggregate of all stocks. Since there are many thousands of stocks in the US markets and many thousands more in foreign markets, what do we look at to see a summary of what is going on? The market is summarized into indexes. The Dow is one example. There are many others. Each measures a different aspect of the market. S&P 500 (Standard Poor), Russell 2000, etc. are additional examples. Since they measure different things, none is better than another. On your reports every quarter, we list several.
Generally, when people talk about the stock market being up or down a particular number of points, they are referring to the Dow Jones Industrial Average. The index is composed of 30 large cap stocks. Large cap means its market capitalization is in excess of 10 billion dollars. As a result of the 30 companies chosen being so large, people often use the index as a short hand representation of the overall US stock market. That idea is problematic owing to multiple factors such as how the index is weighted and calculated, and the comparatively small number of stocks examined (30 stocks) relative to the number of stocks out there (about 5000 stocks). It is, however, quick and easy to look at.
If you have any questions about these definitions or any others that you encounter, please call at any time. We sincerely hope you got value from this newsletter. We appreciate your business and trust.
Daniel and Eli
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