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A Rich History Underlines the Standard & Poor's Story

November 10, 2005 By:
Craig G. Langweiler
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With nearly half of the companies in the S&P 500 having reported their quarterly earnings, 69 percent have beaten analysts' estimates, up from the 62 percent that did last year and the 59 percent that normally do, according to Thomson Financial.

Earnings are currently running 13.1 percent above last year's double-digit increase, according to Standard & Poor's. If this pace holds, this would mark the 14th consecutive quarter of double-digit earnings growth for the companies in the S&P 500 - a record.

Standard & Poor's currently estimates that profits will be 15 percent higher (year over year) in the third quarter.

What has corporate America been doing with its cash? According to S&P, over the past 12 months, corporate America has increased stock buybacks by 74 percent, dividends by 12.1 percent and R&D by 3.3 percent.

The companies in the S&P 500 are currently buying back about $70 billion worth of stock per quarter, up 65 percent on a year-over-year basis, according to Howard Silverblatt, equity analyst at Standard & Poor's. Historically, less than 25 percent of companies buying back shares actually reduce share count. Today, that figure has grown to nearly 50 percent.

S&P believes this trend will continue as more companies utilize their large cash holdings in an attempt to boost earnings-per-share growth and shareholder value.

Since 1950, November has marked the start of the best three-month span and six-month period for the stocks in the S&P 500, according to the Stock Traders Almanac. The average gain posted in both November and December since then has been 1.7 percent. January is ranked third, with an average gain of 1.5 percent.

The S&P 500 has posted gains in the fourth quarter in each of the past four years: 8.7 percent (2004), 11.6 percent (2003), 7.9 percent (2002) and 10.3 percent (2001). The index began the fourth quarter of 2005 by posting a 1.7 percent loss.

Just how is the value of the S&P 500 calculated? The S&P 500 is a U.S. market index that gives investors an idea of the overall movement in the U.S. equity market.

The value of the S&P 500 constantly changes based on the movement of 500 underlying stocks that make up the index. The index is computed by weighted average market capitalization.

The first step in this methodology is to compute the market capitalization of each component in the index. This is done by taking the number of outstanding shares of each company and multiplying that number by the company's current share price, or market value.

For example, if Apple Computer has roughly 830 million shares outstanding and its current market price is $53.55, the market capitalization for the company is $44.45 billion (830 million times $53.55).

Next, the market capitalizations for all 500 component stocks are added to obtain the total market capitalization of the S&P 500. This market capitalization number will fluctuate as the underlying share prices and outstanding share numbers change.

In order to understand how the underlying stocks affect the index, the market weight (index weight) needs to be calculated. This is done by dividing the market capitalization of a company on the index by the total market capitalization of the index.

For example, if Exxon Mobil's market cap is $367.05 billion and the S&P 500 market cap is $10.64 trillion, this gives Exxon a market weight of roughly 3.45 percent ($367.05 billion/$10.64 trillion). The larger the market weight of a company, the more impact each 1 percent change will have on the index.

If Exxon Mobil were to rise by 20 percent while all other companies remained unchanged, the S&P 500 would increase in value by 0.6899 percent (3.45 x 20).

If a similar situation were to happen to The New York Times, it would cause a much smaller, 0.0076 percent change to the index because of the company's smaller market weight.

• • •

What is a spider, and why should I buy one?

A spider is a financial instrument that derives its name from the abbreviation SPDR, which stands for Standard & Poor's depository receipt.

This type of investment vehicle is classified as an exchange-traded fund that enables an investor to gain exposure to a large number of securities, particularly those of the companies that make up the S&P 500 index.

One of the reasons for buying a SPDR is that it is a quick and easy way to have significant diversification. SPDRs are also relatively inexpensive compared to what it would cost to create this type of portfolio yourself.

SPDRs contain one-10th of the S&P 500 index portfolio, which is why the cost to buy one unit of this asset is nearly equal to one-10th of the S&P 500 index level. Because SPDRs offer exposure to many companies, they are generally deemed to be a stable investment.

SPDRs trade on the American Stock Exchange under the symbol SPY in the same manner as regular stocks, have continuous liquidity when the market is open and provide regular dividend payments.

This type of investment is ideal for those who believe in passive management, a strategy that attempts to mirror a market index with no desire to try and beat the market.

Craig Langweiler is president of the Langweiler Financial Group, in Newtown. He can be reached at 215-860-8066 or at: clangweiler@americanportfolios.com.

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