<FOOLISH FOUR PORTFOLIO>

Calculating the Dow
How to get that 10,000 number

by Chris Rugaber (TMF [email protected])

Alexandria, VA (March 18, 1999) -- Now that the Dow may soon close above 10,000, it's finally getting its share of media attention after recently seeming to slip into the shadow of the Standard & Poor's 500 Index. Our fellow Fool Dale Wettlaufer (TMF Ralegh), over in the Boring Portfolio, has been all over MSNBC, trying to explain that the milestone doesn't mean that much, but it's unlikely he'll have much success changing the media's superficial focus. But hey, we Dow investors are happy to have the attention. Go Dow 10,000!

Of course, Dale is correct and the 10,000 mark doesn't really matter. In fact, if you saw Dale's Lunchtime News column last Friday, you would have seen him make a reference to a "divisor," and how if you split it, "no one would be celebrating the 10,000 mark." This indicates one use of Dow 10,000: as a teaching tool. After all, how is the Dow Jones Industrial Average (DJIA) calculated? And what is this "divisor"?

As those who've read our Foolish Four guide know, the DJIA is calculated by essentially adding the prices of the 30 Dow stocks together and then dividing them by a divisor, which, of course, used to be 30. However, since the divisor was set in 1928 it has been repeatedly reduced over the years to compensate for stock splits, dividend payments, and so forth. For example, if a stock split or other non-event changes the Dow by more than 5 points, then the divisor is reduced by whatever amount necessary to return the index to its previous level.

The divisor is now 0.22522230 and can be found in the Wall Street Journal's "Money & Investing" section or at http://averages.dowjones.com/divis_ia.html. The divisor is revised fairly often, so if you continue to use 0.22522230 a few weeks from now, you'll probably start getting incorrect numbers.

All Fools can do this on their own -- amaze your friends by calculating the Dow yourself! Go to Today's Stock Lists, linked at the end of each day's Foolish Four article, and take the closing prices of all 30 Dow stocks, add them up, and divide by 0.22522230. You should get the same number as we report in our Evening News as the Dow's closing number.

This focus on each stock's price (and the relatively low number of stocks in the average) makes it easier to calculate each stock's impact on the DJIA as a whole, as opposed to other indices such as the S&P 500. This is why you will sometimes see particular companies "blamed" or "credited" with changes in the Dow. By dividing a company's price change by the divisor, you can get a sense of the stock's impact on the overall Dow average. For example, last Friday, Caterpillar <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAT)") else Response.Write("(NYSE: CAT)") end if %> dropped $6 3/16. If you divide that by 0.22522230, you get roughly 27.46. Therefore, Caterpillar could technically be "blamed" for reducing the Dow by 27 points or so. Of course, this is little more than a parlor game, but hey, keep score at home and know which company to blame if we come close to 10,000 again and miss!

By the way, did I mention Caterpillar? Sometimes even the Internet isn't fast enough to keep up with breaking developments. Not long after I posted an article last week on Caterpillar's 1998 income statement and made some mildly positive comments about it, the company released an earnings warning stating that their first quarter earnings for 1999 may be 50% below estimates. The stock quickly dropped about 12%, as mentioned above.

Since then, Caterpillar has gained some of it back, closing Wednesday up $3 1/4, thanks largely to some analyst upgrades. This quick up-and-down is as good an indication as any of the short-term nature of what's going on. Sure, earnings 50% below estimates are nothing to be happy about, but as Foolish reader "damguy" pointed out on the Caterpillar message board, better that the company warn analysts early.

Generally, Caterpillar is continuing to face declines in demand, in part due to Brazil's troubled economy and in part due to declining commodity prices worldwide, which weakens its agricultural and mining customers. Much of this has been going on for a while, so again, it's not too big a deal. The company has announced plans to temporarily close some plants, cut inventory, and reduce jobs by an unspecified amount. They are also planning to reduce R&D and sales, general, and administrative (SG&A) expenses.

This is somewhat inevitable given the price pressures and other challenges facing the company, and, as we discussed last week, SG&A and R&D certainly increased faster than sales last year, so perhaps they are a little high. However, much of this is due to long-planned "growth initiatives" by Caterpillar rather than sloppy management or anything like that. As a result, we may not want them to cut things like R&D too much. It seems that Caterpillar is facing a fairly typical business dilemma: when business is slow, how much should you cut back to help the short-term bottom line, and how much should you continue to spend and invest to build the business for the long term? Long-term investors, of course, would prefer more of the latter, and that's what Caterpillar has done so far. We'll return to Caterpillar next week and continue our study of the company. Until then, Fool on!

Today's Stock Lists | 1998 Dow Returns

03/18/99 Close

Stock Change Last -------------------- CAT - 7/16 46.81 JPM +2 11/16 124.19 MMM -2 3/4 73.63 IP +1 1/8 45.56

Day Month Year History FOOL-4 -0.00% 5.29% 6.36% 7.94% DJIA +1.20% 7.43% 9.28% 8.84% S&P 500 +1.44% 6.32% 7.42% 7.68% NASDAQ +1.40% 7.65% 12.33% 13.87% Rec'd # Security In At Now Change 12/24/98 9 JP Morgan 105.51 124.19 17.70% 12/24/98 24 Caterpillar 43.08 46.81 8.66% 12/24/98 22 Int'l Paper 43.55 45.56 4.62% 12/24/98 14 3M 73.57 73.63 0.07% Rec'd # Security In At Value Change 12/24/98 9 JP Morgan 949.62 1117.69 $168.07 12/24/98 24 Caterpillar 1034.00 1123.50 $89.50 12/24/98 22 Int'l Paper 958.12 1002.38 $44.26 12/24/98 14 3M 1030.00 1030.75 $0.75 Dividends Received $15.04 Cash $28.26 TOTAL $4317.61 </FOOLISH FOUR PORTFOLIO>