Advertisement
Markets

When the Dow Should Hit 50,000 and Why

Hint: It's just a math equation.

Many of my own clients have come to me alarmed by the fact the Dow Jones industrial average surpassed a record high and is nearing 20,000. This got me to thinking, where should the Dow be valued, and why?

First, we have to define what makes ownership of equities go up in the first place. Equities are partial ownership shares of corporations. Corporations are in the business of making a profit. A typical measure of profitability is the forward-looking price-earnings ratio (P/E). For purposes of this hypothetical analysis, let's assume the long-term average P/E is 16.67 for Dow stocks. This means that for every $100 invested into the ownership of these corporations, your share of next year's profit will be 100/16.67, $6.00 or simply 6% of the company value for purposes of this analysis.

Advertisement - Article continues below

Assuming corporations earn 6% of their outstanding stock value in a year, we can also theoretically assume their underlying value is 6% more after a year due to the fact that the company has more equity available to benefit its shareholders than it did a year ago.

Companies typically grow their earnings over time. Assuming average growth of net earnings is 7% per year, we can compute that in a five-year period of time, the cumulative profits of a company will be about $40 for every $100 invested.

Advertisement
Advertisement - Article continues below

The Dow first eclipsed 1,000 44 years ago, in 1972. We know markets are volatile, but what happens when applying a 7% annual compounded increase to the Dow from 1972 to the past, present and beyond? And how did the actual Dow average compare with the 7% compounding figure at critical points in time? In 1981, the Dow was the most undervalued during the last 44 years, trading 52% below the 7% annual compounded trend line ("baseline calculation"). We can all agree that looking back, 1981 would have been a great time to invest as that year signaled the start of the greatest bull market in history.

Advertisement - Article continues below

Fast forward to the end of 1999, the market calculates to being the most overvalued in 44 years, trading at 85% over the baseline calculation. The subsequent crash nearly wiped out the entire 85% of frothy optimism priced into that market. At the end of 2007, again the market was substantially higher than the baseline calculation, indicating another great time to sell. By the close of 2008, the market achieved another great buying opportunity by closing 23% below the baseline calculation.

What about the market today? By starting at 1,000 in 1972 and compounding at 7% per year through 2016, the computed Dow would be at 19,600. In December of 2016, the Dow crossed that level, exactly as computed.

Extrapolating forward, we unearth more interesting results. The year 2020 marks where this math equation takes us to 25,000. In a mere 14 years, in 2030, the equation says the Dow would reach 50,000.

Stock market investing requires much more than simple math. But after reviewing this data, perhaps we can conclude that the simplest concepts combined with common sense could be our greatest ally when making solid investment decisions.

Disclosure: Madrona Financial Services, LLC, and its Investment Advisers cannot and do not guarantee the performance of any investment or insurance product. Past performance is not a guarantee of future results. Investors cannot invest directly into indexes.

About the Author

Brian Evans, CPA, PFS

Owner, Madrona Financial Services

Brian Evans is the owner of Madrona Financial Services, Madrona Funds, LLC, and Bauer Evans CPAs and serves as the firms' chief investment officer, lead planner and senior portfolio manager. He was honored to ring the bell on the NYSE. Evans also hosts a weekly radio show on KTTH 770 AM, KRKO 1380 AM and KVI 570 AM, is a nationally published author and has been a regular guest on New Day Northwest, CNBC and Fox television.

Advertisement

Most Popular

2020 Stock Market Holidays and Bond Market Holidays
Markets

2020 Stock Market Holidays and Bond Market Holidays

Is the market open today? Take a look at which holidays the stock markets and bond markets take off in 2020.
July 1, 2020
What Are the Income Tax Brackets for 2020 vs. 2019?
tax brackets

What Are the Income Tax Brackets for 2020 vs. 2019?

The IRS unveiled the 2020 tax brackets, and it's never too early to start planning to minimize your future tax bill.
June 20, 2020
Searching for the Perfect Place to Retire
Empty Nesters

Searching for the Perfect Place to Retire

We home in on two places with less traffic and lower costs. 
July 2, 2020

Recommended

3 Municipal Bond Funds for Rich, Tax-Friendly Yields
Investing for Income

3 Municipal Bond Funds for Rich, Tax-Friendly Yields

Municipal bond funds allow you to enjoy the benefits of tax-exempt income. By investing CEFs, you can sweeten the pot even further.
July 2, 2020
Is the Stock Market Closed for the Fourth of July?
Markets

Is the Stock Market Closed for the Fourth of July?

Independence Day falls on a Saturday in 2020. As a result, the bond and stock markets are closed for a long holiday weekend. Here's a look at the mark…
July 2, 2020
2020 Stock Market Holidays and Bond Market Holidays
Markets

2020 Stock Market Holidays and Bond Market Holidays

Is the market open today? Take a look at which holidays the stock markets and bond markets take off in 2020.
July 1, 2020
13 Best Vanguard Funds for the Next Bull Market
mutual funds

13 Best Vanguard Funds for the Next Bull Market

Optimistic that the bounce since March is indeed the start of the next bull market? Here are the 13 best Vanguard funds to help you make the most of i…
June 25, 2020