Weighted vs. Unweighted

 In The Lonely Bull

The most popular stock index in our market is the S&P 500.  This is a weighted index, meaning that each company in the index carries a weight based upon the their capitalization or size.  For instance Apple Corp. is one of the heaviest weighted firms in this index.  (The Dow Industrial Average is also a weighted index.) 

This means that the performance of the largest firms move the index the most.  Over the past two years the S&P 500 index has gained 26.62%.  If one didn’t weight each company for size (market capitalization) but treated each as equal the two year return is only 4.58%. 

This dramatic difference points to how much larger firms out-performed smaller ones.  In fact, the largest firms have had an exaggerated affect.  This may reflect reality; one that recognizes that the strong are getting stronger at the expense of all others.  However, this also leads to money management professionals and other investors to accentuate these simply because they are performing.  The ultimate risk is that these few stocks become too expensive relative to their real opportunities.  This happened to the “nifty fifty” during the 1970’s.  The result was that a small group of good companies became so overpriced that eventually they fell back to earth.  The same thing could happen to the new “nifty growth” stocks of today. 

We believe in appropriate diversification and analysis of true value. 

We are prepared; stay steady, my friends.

the Lonely Bull

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