<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (May 26, 1998) -- Over the last several decades, the two major large-cap indices (the Dow Jones Industrial Average and the Standard & Poor's 500 Index) have moved pretty much hand in hand. If you beat one, you usually beat the other.

But in recent years, that's becoming less and less true. For example, over the last 12 months the Dow is up 29.67% (through May 20). But the S&P 500 Index is up 40.89%. That's a difference of 38% between the two indices that many people casually treat as synonymous.

Why the big difference recently? It has to do with the makeup of the indices themselves, of course, but even more, it has to do with the calculation of the indices.

The DJIA is a price-weighted index, meaning the prices of all 30 stocks are added and then the sum is divided by a floating element used to adjust the index for events such as stock splits and revision of the stocks in the index. As a price-weighted index, the stocks with the highest stock prices carry the most influence. A $100 stock in the Dow has a tremendous amount of influence over the index's movement, while a $20 or $30 stocks has little.

The S&P 500 Index, however, is a market-cap weighted index, so the largest stocks influence it the most, not the stocks with the highest prices. The Dow 30 are all in the S&P 500 Index, of course, and until very recently the Dow 30 were enough of an influence on the S&P 500's top spots that the two indices moved roughly in tandem.

Today, however, several of the nation's largest companies are not in the Dow at all. These companies (technology and drug behemoths, mostly) have a great influence on the S&P 500 but none on the Dow. Given the power of technology and drug stocks over the last decade, the market-cap weighted S&P 500 has enjoyed a bigger push from these powerhouses.

In fact, of the seven largest companies in America today, three are non-Dow stocks: Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>, Pfizer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PFE)") else Response.Write("(NYSE: PFE)") end if %>, and Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>. Over the last three years, these three companies have posted an average annualized return of 62.5%. With that kind of power boosting the S&P 500 returns but not affecting the Dow, it's no wonder the two indices have experienced some separation.

Does any of this have a practical aspect for investors? Perhaps. If you're trying to decide between the new Dow Diamonds <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: DIA)") else Response.Write("(AMEX: DIA)") end if %> and the S&P 500 Spyder <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: SPY)") else Response.Write("(AMEX: SPY)") end if %> as a place for parking some cash while looking for new stocks, you might consider this discrepancy. If you want the influence of the Microsofts and Intels and Pfizers in your index fund-like investments, you'd be better off with the Spyder than with the Diamond. (You'd never have guessed that as a child, now, would you?)

But if nothing else, knowing how these indices are calculated will help you monitor your own investments better. For example, last year the Foolish Four managed to beat the Dow but trailed the S&P 500 because of the different influences on the larger index. Food for Foolish thought!

Current Dow Order | 1998 Dow Returns

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   -1  3/4   50.88 
 IP   -1  1/16  49.69 
 MO   -   3/8   36.94 
 EK   +   3/16  70.75 
 
 
                    Day   Month    Year 
         FOOL-4   -1.60%  -0.82%   8.70% 
         DJIA     -1.65%  -1.10%  13.35% 
         S&P 500  -1.48%  -1.60%  12.74% 
         NASDAQ   -1.49%  -4.83%  13.23% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  291 Union Carb    42.94     50.88    18.49% 
  12/31/97  206 Eastman Ko    60.56     70.75    16.82% 
  12/31/97  289 Int'l Pape    43.13     49.69    15.22% 
  12/31/97  276 Philip Mor    45.25     36.94   -18.37% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  291 Union Carb 12494.81  14804.63  $2309.81 
  12/31/97  206 Eastman Ko 12475.88  14574.50  $2098.63 
  12/31/97  289 Int'l Pape 12463.13  14359.69  $1896.56 
  12/31/97  276 Philip Mor 12489.00  10194.75 -$2294.25 
  
  
                              CASH    $415.96 
                             TOTAL  $54349.52