1,000 Point Drop in the Dow: Who Cares?
A 1,000 point nearly instant drop in the Dow — just the stuff to make cocktail-party-goers and politicians froth.
But for us normal folks, does the bouncing around of far removed financial markets matter? For many, it seems like Monopoly money…who cares?…especially when the markets essentially bounce back to pre-drop levels?
For those of us of the finance persuasion, and for everyone else, too, volatility does matter, for we believe that value is a function of future benefits and risk. And risk is defined as the volatility of the future benefits.
Thus, if you have two horizons of future benefits (e.g., net income/profits, free cash flow, or EBITDA) which are of the same aggregate nominal amount, but the periodic flow of one stream of benefits bounces around more that the other, the more volatile or “bouncy” flow of benefits is worth less than the less volatile flow.
So, that is why investors are willing to enjoy a much lower return from, say, an investment in a high dividend paying, stable utility company’s stock than, say, an investment in a volatile technology company’s stock.
The thrill of a 1,000 point drop in the Dow is not for retirees only…the rest of us should get the heebie-jeebies, too!
Posted on Sat, May 8, 2010
by Timothy E. Moffit