THE MARKET AVERAGES They Should Be Used with Caution

THE MARKET AVERAGES

They Should Be Used with Caution

DURING the first years of the great Bull Market rise, many U.S. investors "played the averages." They bought blue-chip stocks used to compute stock averages, notably those in the Dow-Jones average, and made money because it was a blue-chip market in which the leaders rose fastest. But in 1956, playing the averages did not pay off; the blue chips backed and filled all year long. Last week, in the first days of 1957, almost every Wall Street commentator was warning investors to beware the averages this year; playing them would not pay. Blue-chip prices are now so high that the Dow-Jones 30 industrials yield only 4.55% v. a yield of 4.29% for 40 bonds. Said Paine, Webber's topflight Analyst Luttrell Maclin: "The Dow-Jones is a mathematical monstrosity. It's the weakest kind of a crutch for the investor."

The main trouble with the averages is that they represent only a relatively small sampling of the total 1,501 stocks on the New York Stock Exchange. Thus they do not always agree--or even accurately reflect what is happening in the whole market. In one recent week, for example, all four of the best-known averages differed on how the market had acted.

While the averages are useful tools to Wall Street's professionals, they can mislead amateur investors into buying or selling at the wrong time. Many investors seldom bother to learn how the averages are compiled; nor are they aware of what they really mean. Investors, for example, often talk of a "$6 rise" on the Dow-Jones industrial average. Actually, the Dow-Jones is not a dollar average at all, but a point average. Dow statisticians calculate it by totaling the per-share value of 30 prime industrial stocks (among them: Du Pont, General Motors, General Electric, U.S. Steel), then dividing the sum by a "constant divisor" which they adjust to account for stock splits. Currently, the divisor stands at 4.566, meaning that each point in the average is equal to $1 divided by 4.566, or about 22-c-. Thus, a 6-point jump is only about $1.32 in actual dollar value, a fact some amateurs learn to their chagrin when they rush to make a killing as the Dow average rises.

As a result, many Wall Streeters feel that unwary investors can get a highly exaggerated picture of market movements by following Dow-Jones too closely. Furthermore, they emphasize that Dow-Jones bases all its calculations on the value of just one share of stock in each of its 30 companies, without regard to size or importance. Thus, Bethlehem Steel, selling at $192, carries almost three times the weight of U.S. Steel (selling price: $71) and four times the weight of General Motors (price: $43), both of which are much bigger companies.

The other big investor favorite, Standard & Poor's 90-stock compilation, is calculated on another basis. Like the Government's price indexes, it expresses the value of its stocks relative to a base period, currently the years between 1935 and 1939. Some professional traders prefer the Standard & Poor because its greater number of stocks presents a broader picture of the market and also because they feel that it is statistically superior. But the fact is that Dow-Jones and Standard & Poor are in fairly close agreement from day-to-day. Both show the same broad ups and downs in the market, and their analysis of the degree of change often matches.

Nevertheless, every real Wall Streeter knows that Standard & Poor's daily average, like the Dow-Jones, is only a sketchy cross section of the whole market and thus attempts merely to show the broadest changes in trading sentiment. On a weekly basis, Standard & Poor does publish a mammoth index of 480 stocks, but for hourly and daily operations, it is impractical to calculate, such a wide selection, thus statisticians limit themselves to what they hope is a small but representative sampling. As a result, the averages sometimes show a rise in the market, when the fact is that the majority of stocks, most of which cannot be included, have gone down.

To drive home their point, professionals like to tell the story of three men who went to Nairobi to start on a 14-month safari. When they left, the Dow-Jones average stood at 485, and when they got back, it was still at the same level. But one man found that his stocks had doubled in value; the second found that his had remained the same; and the third discovered that his investments had been cut in half.

Thus, say Wall Streeters, the wise investor should pay more attention to earnings and dividends of individual stocks, plus the overall stability of the U.S. economy and its future prospects before deciding whether the market--and any individual stock--is too high or too low. Says Walston & Co.'s top Analyst Tony Tabell: "Everyone would be a lot better off if they forgot the averages entirely and concentrated on individual stocks, but we can't seem to get it through to the public."

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