Does Dow 16,000 Really Matter?


The Dow Jones Industrial Average passed 16,000 today, the latest in a long list of milestones hit by the index this year. The occasion will make for a lot of good headlines, but does it really matter for investors?

Let's take a look at what 16,000 really means and why it may be a warning for investors.

Stocks are driven by earnings ... sort of
At the end of the day, the stock market is driven by earnings. On that front, it's true that the economy is improving, and as a result corporate profits are higher. But are they really up enough to drive the Dow Jones Industrial Average above 16,000?

Below is a chart of the increase in net income for Boeing , Nike , and General Electric . These companies not only offer a good cross section of the Dow, they're the three best performers since the index hit 15,000, respectively gaining 47%, 24%, and 21%.

As you can see, company earnings are up over the past three years, but not nearly as much as the index itself. That means the value investors are getting in stocks isn't what it once was.

BA Net Income (TTM) Chart
BA Net Income (TTM) Chart

BA Net Income (TTM) data by YCharts

If this chart tells us anything, it's that there's one big driver of stocks that we shouldn't overlook: multiple expansion.

Today, we're paying more for those earnings
Multiple expansion is when the P/E ratio of a stock or index goes up. Since the year-ago period, investors are paying significantly more for each dollar of earnings, which has been the real driver of the market. The chart below shows that expansion in Boeing, Nike, and General Electric.

BA P/E Ratio (TTM) Chart
BA P/E Ratio (TTM) Chart

BA P/E Ratio (TTM) data by YCharts

Most shocking is the huge jump in what investors are willing to pay for Boeing's earnings. Investors must be expecting huge growth in the future because 98% of Boeing's total return over the past year is from an expanding multiple, not increasing earnings.

These three stocks are a small snapshot of the Dow, but they show the general trend that's taken place. Over the past year, the Dow's P/E ratio has gone from 13.75 to 17.88, which accounts for most of the index's rise. Dow 16,000 is a nice move, but there's not a lot of fundamental earnings growth behind it, which should be at least a small concern for investors.

Is Dow 16,000 a big deal?
In the grand scheme of things, an index of 30 stocks passing a specific number isn't all that big a deal. In this case, it really points out how stocks have risen largely without the backing of significant earnings growth.

If you're an investor seeking value stocks, the market is offering slim pickings right now. That's the main t thing I'm taking away from Dow 16,000.

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Fool contributor Travis Hoium has no position in any stocks mentioned. The Motley Fool recommends Nike. The Motley Fool owns shares of General Electric Company and Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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