Dow Jones Today: Can 1 Simple Number Boost Your Returns?

Some think that this one simple indicator is a way to get better returns. But does it really work?

Feb 23, 2014 at 9:01AM

Few companies get scrutinized more closely than the 30 stocks in the Dow Jones Industrials (DJINDICES:^DJI). Given how popular the Dow is, investors search high and low to find strategies that can beat its returns. In this look at the Dow Jones today, let's look at whether the simplest of characteristics could actually hold the secret to market-beating returns: a stock's price.

Image source: Rafael Matsunaga, Flickr.

2 "theories" why stock price matters
You'll actually find opposing theories about how a stock's price affects returns. On one hand, some investors gravitate to stocks with low prices, arguing that they have the most room to run higher. On the other hand, some look for high-priced stocks, pointing to the fact that in order to attain such heights, the stocks have to have put in solid performance in the past.

The problem is that by itself, share prices don't tell you anything about the value of a particular company. For years after the financial crisis, Bank of America (NYSE:BAC) was among the lowest-priced components in the Dow, with share prices falling almost to the $5 as recently as late 2011. Yet even though it would still be the lowest-priced stock if it were still in the Dow Jones today, Bank of America has a market capitalization of more than $170 billion -- making it an unlikely candidate for the huge growth potential most people expect from low-priced shares.

Similarly, higher-priced stocks usually do have a demonstrable level of past outperformance, as artificial share-price inflation through reverse stock splits almost never happens. But performance in the past doesn't tell you whether those high-priced stocks will keep rising. Some such stocks keep rising into the stratosphere, while others fall back to earth as their prospects flare out.

A look at high- and low-priced stocks in the Dow Jones today
When you actually look at the 30 companies in the Dow Jones today and their stocks, you'll find little correlation between share prices and long-term returns. Over the past five years, the nine top-priced stocks in the Dow have all doubled or more in value, but that's true for nine out of the bottom-priced 11 Dow stocks as well. Like Bank of America, General Electric (NYSE:GE) was hit hard by the financial crisis, but it has tripled in value since early 2009 even though its shares still carry a low price below $25. The company has largely reinvented itself, but it hasn't seen any need to do a reverse split to keep up with some of its higher-priced competitors in the Dow.

At the other end of the spectrum, Visa (NYSE:V) has quadrupled in value in the past five years and carries the highest price in the Dow. With a market cap of $140 billion, Visa might not have as much room for growth as it had in the past, but many have pointed to the potential from international expansion as a potential growth driver that could push Visa higher for years to come.

Perhaps the best counterargument on share prices and returns is that the best performer in the Dow over the past five years has a middle-of-the-road share price. American Express (NYSE:AXP) has climbed almost 650% since early 2009, but its share price of around $89 puts it at No. 12 out of the Dow 30. You'll find similarly strong performances among other mid-priced stocks as well.

Look beyond price
Focusing on share price is an easy indicator to follow. But at least in the Dow Jones today, share prices won't tell you much about a company's past performance, let alone its future prospects. You're much better off looking beyond the simplicity of share prices to make smart investment choices.

Our top stock for 2014
What's more important than price is whether a company's fundamentals are solid. On that score, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Dan Caplinger owns warrants on Bank of America. The Motley Fool recommends American Express, Bank of America, and Visa and owns shares of Bank of America, General Electric, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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