RESTON, VA (Oct. 22, 1999) -- Last month I wrote about a new book, Dow 36,000. Not long after that another new book arrived in our offices for review: Dow 40,000 by David Elias. I admit it -- I snorted when I saw it, especially when I read on the back jacket that the author was predicting that the Dow would hit 40,000 by the year 2016.
Let's do the math. If the Dow is at approximately 10,000 now, it would have to quadruple to reach 40,000, right? That means it would have to double twice: 10,000 x 2 = 20,000, 20,000 x 2 = 40,000.
So the book is projecting that the Dow will quadruple in the next 17 years. Let's see, that means it would have to double roughly every eight years. The rule of 72 lets me do a quick and dirty estimate of the growth rate. Seventy-two divided by 8 is 9. So Dow 40,000 is projecting that the Dow will grow by an average of 9% per year.
Huh, he's expecting the market to underperform?
Well, in a way, yes. To be fair, the author seems to thoroughly understand compounded growth and its implications. I suspect that the title is the brainstorm of some marketing department wonderkid who had an unflattering, but largely accurate, opinion of Americans' innumeracy. Dow 40,000 is actually a very good book with a comprehensive review of all the reasons why one should be optimistic about the global economy and sound advice about how to profit from a continuing bull market.
I just find the hype annoying -- that people would react to the idea of the Dow at 40,000 as something amazing, when in reality, it only calls for a continuation of the kind of growth that we have seen over the past three decades, which included some really, really bad years. Maybe that would be a miracle. Certainly those who believe that the market is overvalued now and will "revert to the mean" in a devastating crash one day very soon think it would take a miracle for this kind of growth to continue.
I am of the opinion that what we are seeing is an economic revolution that will have the same impact on society that the industrial revolution had. I think the world has reached a confluence of science, communications, transportation, and (this last one appears very fragile and is lagging the rest, but I have hopes) global democracy. Barring major wars or unforeseen planet-wide disasters, and possibly even in spite of them, over the next 20 years we will finally see the human potential to create prosperity unleashed.
So, yes, I liked the book, I just didn't like the title.
Here's something to contemplate: How long does it take the market to double? We can get that information from the Dow Jones folks themselves.
It took the Dow 15 years to double when it went from 1000 in 1972 to 2000 in 1987. (Remember that 1973 and 1974 were the two worst years for the stock market since the Depression.) It took eight years for the Dow to climb from 2000 in 1987 to 4000 in 1995, but only a little over two years to double again to 8000 in 1997. The 3000 to 6000 double occurred from 1991 to 1995, and the 5000 to 10,000 double took four years, from 1995 to 1999.
A crude average of the above numbers would tell us that the Dow has been doubling roughly every seven years since it hit 1000. That's a growth rate of about 10% according to the rule of 72, although the actual compounded annual growth rate is closer to 9%, exactly the growth rate that Mr. Elias is projecting if we are to see the Dow at 40,000 by 2016.
(If you are wondering why that growth number is lower than the growth rate we usually quote for the Dow over this period, it's because the Dow itself doesn't include reinvested dividends. When we compare the Foolish Four with the Dow, we compute the growth of all 30 stocks with dividends reinvested annually. That gives us a fair comparison.)
To hit 40,000, all the Dow has to do is continue growing at the average rate that it has grown for the last 27 years (not the souped-up rate of the last decade). But I suppose if the book were called "More of the Same" it wouldn't have the same shelf appeal.
Maybe the title was Mr. Elias' idea, but he seems quite aware that Dow 40,000 isn't anything radical. In fact, the book includes a chart showing that if the Dow were to grow at a compounded rate of 12% for the next 17 years, it would be closer to 70,000 by 2016. FYI, the growth rate for the Dow has been around 14.5% since 1987. If it kept up THAT pace, the Dow would be pushing (are you ready for this?) 100,000 by 2016. Anybody want to start a pool?
Speaking of innumeracy, I had a touch of it myself yesterday when I was computing the market cap for Philip Morris (NYSE: MO). I missed a digit somewhere and came up with a market cap of "under $6 billion" rather than "under $60 billion." Yes, the market cap has fallen, but not quite that low. The error has been fixed in yesterday's report, but I figured I'd better mention it in case any of my readers were considering just buying the whole company.
Finally, I want to share a note from reader Dave Nace of Columbia, Md., who put Big MO's problems into human terms: "Here's something to think about. MO also owns Kraft Foods and Miller Beer. Just think of the pounding those folks who work for those divisions have taken in any stock-based retirement holdings they might have. They own MO and have no association with the tobacco part of the business."
Very true. Thanks for that perspective, Dave.
While we are looking at the human side of investing, it's a good time to remind everyone that the Fool is taking nominations for its annual charity drive. Let's hear from you about your favorite charity.
Fool on and prosper!