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Taking Stock

Tony Crowell

Tony Crowell

Where Now, New Dow?

Stocks shook off several troubling worries, both foreign and domestic, and powered ahead to a new uptrend, with a strong surge back above 15,000 on the Dow Jones Industrial Average. This famous index of market performance is an old-fashioned arithmetic average of only 30 stocks rather than the broader S&P 500 and NASDAQ Composite which are both weighted to the sizes of the market caps of their components.

Despite this narrower formula, asking anyone in the securities business about “the market” will probably prompt an answer expressed in so many points on “the Dow.” Besides being the most popular short answer on market behavior, it also provides more history for long-range market studies, as it was first calculated by Charles Dow (as in Dow Jones) in 1896.

He began with 12 stocks, of which the only surviving member today is General Electric, added up their prices and divided by 12. It stood then at 62, rose to 78 in 1890 and dropped to its all-time low of 28 during the “Panic of 1896.” Panicked selling has never been a successful investment strategy and the market is up 71,000 percent since then.

The divisor used to calculate the average was increased to accommodate expanding the basket of stocks to 30 companies, and decreased to adjust for stock splits of the components. Remarkably, there have been so many splits, spinoffs and other structural changes over the years that the divisor today is down to 0.13. That equates to a 7.7 movement for every $1 price change for any of the 30 stocks in the DJIA.

If every stock went up or down one point together, the average would be up or down 230 points. This exponential effect is about to expand with new substitutions to the Dow 30. Effective September 20, Alcoa (AA-$8), Bank of America (BAC-$14) and Hewlett-Packard (HPQ-$22 will be replaced by Goldman Sachs (GS-$164), (NKE-$68) and Visa (V-$186).

Since calculation of the DJIA gives exactly the same weight to a one-point change to any of the Dow 30, the substitution of higher priced stocks for those sent home brings an immediate change in the volatility of the DJIA. If the market continues its present uptrend, the DJIA has just taken big step forward toward new highs. Its record close was 15,658 on August 2 of this year. That’s around 300 points from today’s level, a gap that just got easier to cross.

The three stocks just added will receive some buying support, as funds that replicate performance of the Dow will be adding them. Goldman and Nike are strong stocks and Visa is one of my existing picks. I expect it to report earnings per share of at least $7.50 for its fiscal year, which ends on September 30. That’s up from $6.20 last year, a solid growth rate for a company of its size.

Apple (AAPL-$470) isn’t a member of the Dow average even though it still leads everyone in market capitalization. It has a 3% weight among the 500 stocks in the S&P 500, followed by Exxon Mobil (XOM-$88). General Electric (GE-$23), a survivor from the original Dow 12, ranks third. It is reducing its financial activities while its industrial operations are all robust. Earnings per share are growing at 10%; it yields 3.1% and is underpriced. So is Apple, if only for its 2.4% dividend yield.

Apple sold off after its new iPhones announcement, probably a classic case of buying on the rumors and selling on the news. The new 5S phone uses faster 64-bit technology. That doubles the phone speed and may push other smartphone makers like Samsung to speed up adoption of 64-bit processors. ARM Holdings (ARMH-$47) leads in this technology as well as in other advanced microprocessors. The stock isn’t cheap at 45 times this year’s earnings but its growth record is strong.

Overall, although international tensions persist, the global economy has regained some balance this year. Despite fiscal obstacles from Congress, the U.S. economy continues to make measured progress. Continued growth should send the Dow to another record by yearend.

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. [email protected] 949.494.1376/

800.697.2622 www.crowellroberts.com

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