Q. If the market keeps setting record highs, does that mean stocks are getting expensive?
A. By some measures, yes. The long drive up in the market has sent a key barometer of how expensive stocks are above its long-term average.
A stock’s price is meant to reflect how much investors expect a company to earn in profits. If those profits grow, you’d expect the stock to rise. Sometimes, though, stock prices rise even if earnings don’t, and that’s when stocks start to look expensive relative to their historical norms.
One widely used measure of value divides the price of the Standard & Poor’s 500 index by the annual earnings at those companies over 10 years, adjusted for inflation. That number is currently 28.7, a bit above where it was 10 years ago but far below where it was prior to the dot-com implosion of 2000-2002. Since World War II, the average ratio has been 19.
Q. I’m embarrassed to ask, but what exactly does the Dow Jones industrial average measure?
A. The Dow Jones industrial average is calculated using the prices of 30 large, or “blue chip” stocks from various U.S. industries. It’s been around since 1896, when it started out with 12 companies, one of which was General Electric, which is still in the index.
