The Dow Jones Industrial Average (DJINDICES: ^DJI ) closed the week at 15,570, less than 1% below its all-time record high. Yet as the fifth anniversary of the financial crisis is upon us, the question many investors are asking is whether the Dow 20,000 level will be the next major milestone to get breached, or whether a bear market will send stocks back to Dow 10,000 or even further downward into four-digit territory. Let's take a closer look at the arguments for both sides.
Why Dow 20,000 isn't so far-fetched
Arguing for Dow 20,000 might seem like a symptom of the greed that so often surfaces near market tops. But when you look at the fundamental economic health of the Dow's components, Dow 20,000 doesn't seem nearly as much of a reach.
A simple earnings-multiple-based approach shows just how reasonable Dow 20,000 sounds. Right now, aggregate consensus operating earnings for the 30 Dow components adds up to just under $1,050 annually, equating to an earnings multiple at current levels of just under 15. That isn't ridiculously cheap, but it's far from the most expensive multiple the Dow has ever sported. Looking forward to 2014, analysts see earnings rising to about $1,135, putting the current Dow at less than 14 times forward earnings.
An immediate jump to Dow 20,000 would raise those multiples to around 19 and 17.6, respectively. Even those higher multiples don't represent records, and bulls could argue that low interest rates justify higher stock market valuations.
Moreover, if you look further out, you'd give Dow earnings even more time to grow. In that case, by the time we hit Dow 20,000, earnings might well have grown enough to make the then-prevailing earnings multiple look downright normal.
The road to Dow 10,000
On the other hand, many scared investors have far less trouble believing a potential drop to Dow 10,000. After all, that level would represent about a 36% drop -- almost the same as the stock market's plunge during the 2008 financial crisis.
What could cause a plunge to Dow 10,000? There are a couple of likely scenarios:
- Several high-priced Dow components, which have the greatest influence on the average, have relied on substantial growth to justify their rich multiples. Visa (NYSE: V ) trades at more than 25 times 2013 earnings estimates and is the highest-priced stock in the Dow. Boeing (NYSE: BA ) has climbed to more than 19 times 2013 forward earnings. Both Visa and Boeing have huge growth prospects, with Visa looking for its electronic-payments network to capture a greater percentage of worldwide transactional activity, while Boeing has identified a nearly $5 trillion opportunity to deliver aircraft to customers hungry for modernized fleets with greater efficiency. Any threat to those high-growth stocks could send their multiples back toward the Dow's overall level, and such a move in just those two stocks could take 1,000 points off the Dow.
- On the other side of the coin, several more of the Dow's highest-priced stocks are slow-growth giants under various threats of their own. Goldman Sachs (NYSE: GS ) has struggled with the recent damage to the bond market, and greater regulation threatens its long-term prospects. IBM has delivered disappointing revenue figures for several quarters now, and the sluggishness in its results could eventually prove too severe for IBM to overcome using share repurchases and other tactics to keep earnings-per-share figures rising. And in the oil sector, Chevron (NYSE: CVX ) faces the constant challenge of keeping production high. Failures from any of those stocks could cause earnings to erode quickly, which in turn would push share prices lower and pull the entire average down toward Dow 10,000.
Prepare for whatever comes
Knowing whether Dow 20,000 or Dow 10,000 will come first would require a crystal ball, but one thing is simple to understand: regardless of whether we see Dow 10,000 ever again, it's almost a given that whether it takes months, years, or decades, Dow 20,000 will eventually become reality.
Because of that, it really doesn't make sense for long-term investors to stay on the sidelines. Yet that's exactly what millions of Americans have done for yeras, missing the huge gains in the Dow since 2009. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.