Author Topic: Question about stock market value  (Read 1491 times)

Morpheus

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Question about stock market value
« on: June 09, 2015, 03:59:22 AM »
My first post in the MMM community - so far I'm learning a lot!

I wanted to ask what is the indicator that represents the current stock market value?
I was reading this thread: http://forum.mrmoneymustache.com/investor-alley/a-crash-is-coming/
and someone posted the attached chart that represents the stock market value in respect to time, what is that value (how is it called), what does it represent? how can the stock market value be evaluated as a whole?

Thanks!

matchewed

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Re: Question about stock market value
« Reply #1 on: June 09, 2015, 05:51:59 AM »
So to understand how the stock market value is measured and understood you must start with the "what is the stock market?" question.

The stock market is all the publicly traded companies presenting their shares out there in a market for buying/selling. So any particular company will have a certain number of shares that any ol' person can buy or sell. That price for buying or selling is determined by how much other people are willing to buy or sell it.

We've established now how a single company's price is determined. So how is the stock market determined as a whole (or frankly a slice)? Well one way to do it is by how "large" a company is and to use that "size" as a proportional weight when looking at all the companies in the stock market. This "size" is called a market capitilization (or market cap) and is a measurement of all a company's outstanding shares multiplied by the share price.

So now you have the market cap and you're using it as a proportional weight, well what does that mean? Let's assume I open an index fund that will track all the companies in the stock market. And there are 10 companies in the stock market. Companies A, B, C, D, E, F, G, H, I, and J. And they have market caps that when broken down into percentages look like this (respectively), 20%, 15%, 13%, 11%, 9%, 8%, 7%, 6%, 6%, and 5%. Well I'm going to use that money in the index fund to buy an amount of shares from each company to maintain that percentage of concentration in my portfolio (the proportional weight). As the market changes I buy and sell appropriately. This is the basis behind an index fund, there are more complicated index funds but we're going to ignore them for now.

So how does that answer your basic question? Well a method of evaluating the stock market as a whole is to just look at a total market index fund (VTSAX for instance). Other people use the S&P 500 as their barometer as it generally tracks with the overall stock market (since it is the biggest 500 companies it generally drives the upward or downward movement of the market as a whole). And some people use the NASDAQ composite for their metric.

I hope this has helped a bit. :)

Aphalite

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Re: Question about stock market value
« Reply #2 on: June 09, 2015, 06:59:00 AM »
To add to what matchewed said, the individual stocks' price is determined by the market's expectation of the future cash flows it will eventually return to the investors (in relation to alternative investments such as fixed income or real estate). There's several ways a company can do that. It can 1) reinvest its free cash flow from operations into the business by building factories, paying for advertising to attract new customers, or acquiring new business lines, which results in increased cash flows and thus an increased stock price 2) buy back stock so that each share of stock represents more future cash flow to the investor (lowering the denominator) and 3) distribute free cash flow as dividends

Sometimes market/investor expectations do not align with actual company cash flows, and that's when you have price of the stock going up (actual cash flows exceed expectations) or down (actual cash flows is below expectations)

Livewell

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Re: Question about stock market value
« Reply #3 on: June 09, 2015, 12:07:36 PM »
P/E is a typical way to measure the entire market, I also like to look at the spreads between 5, 10, 30 yr treasury as an indicator of recession (inverting yield curve or not?).

I suggest you start here http://jlcollinsnh.com/stock-series/