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Where will the Dow close at the end of 2011?

Dear Mr. Berko: Can you give our investment club some guidance as to where the Dow Jones industrial might close at the end of the year?

You missed last year by quite a bit, but we still respect your opinions on earnings and dividend projections for the 30 Dow industrial stocks.

And, lastly, can you tell us how the Dow Jones industrial averages are determined? When we add the market values for the 30 stocks and divide by 30, it’s nowhere near the current 11,600 today. We know there’s a magic divisor, and we would appreciate your telling us what it is. – W.A., Aurora, Ill.

Dear W.A.: The magic divisor that is locked away with the secret Kentucky Fried Chicken recipe and the original Coke formula is 0.132129493.

On any given day, if you total the market values of the 30 Dow Industrials and divide by 0.132129493, the result will be the current Dow Jones industrial average.

This weird nine-digit fraction is a consequence of stock splits and stock substitutions that occurred since Chuck Dow and Eddie Jones established Dow Jones & Co. in 1883. Their first publication was a two-page “Afternoon Letter” summarizing the day’s financial news plus the prices of a select list of stocks. And from that list, Chuck and Eddie devised the Dow Jones averages.

Here we go. In 2009, the 30 Dow Jones industrial stocks had combined earnings of $630.37, with Alcoa and Bank of America reporting losses. They paid a collective dividend of $277.91, while Cisco – with its huge cash hoard – remained dividendless.

The Dow closed 2009 at 10,400, and those 30 issues yielded 2.67 percent on the averages’ closing number. And if you would have asked me in February 2009 where the DJI might close at year’s end, I would have blithely said 8,400 or 13.3 times earnings. I was off only by a couple thousand points.

In 2010, the Dow 30 had combined earnings of $811.48. The earnings increased 28 percent over 2009 and paid $287.22 in dividends versus $277.91 (Cisco still refusing to join the dividend parade), a niggardly increase of 3.2 percent or $9.31. The Dow closed 2010 at 11,600, and the Dow 30 had a 2.47 percent yield on the close.

And if asked in February 2010 where the Dow would close, I’d have hemmed and hawed and said 9,600 or 11.8 times earnings. I was only off by a couple thousand points. But at least I’m consistent.

This year, I think the Dow 30 can earn $930.10 versus $811.48, an increase of $118.62, or 14.6 percent. Finally, Cisco decided to pay its first-ever dividend of 35 cents, so the Dow’s collective dividends could come in at $311.12 versus $287.22, an increase of $23.90 or 7.7 percent.

It’s February 2011, and my guess is that the Dow will close at 11,916 for the year just about where it is today. This number puts the Dow at 12.5 times earnings.

I think the current 11,600 Dow tells us that a lot of the forecast recovery is already in the numbers. And 11,600 also takes into account the certain increase in long-term rates as well as inflation, which should begin to head higher in 2011.

And if I’m wrong again, I’ll probably only be wrong by a couple thousand points. The consensus on the Street is somewhere between 12,100 and 16,200. And some analysts who have been smoking too many of those left-handed luckies think the Dow Industrial could close at 20,000.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com.

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