l

c A S E ' THE MIDLANle

l' he Mid/and Inquirer

Stock Market Indexes)

.Ih-I Ail—i

Henry Teaford, a brand-new business school graduate, was recently hired as an _ I

assistant to George Law, the business editor of the Midland Inquirer. Henry’s
first job was to secure the information for the Midland Inquirer Oil Index and
write a short— column for the Tuesday through Saturday editions of the In-
quirer, describing the activities of the seven pstocks composing the index. A
QUESTIDI
typical column is shown in Table 2.1.

In reality, Henry had to do little to prepare the column. A local brokerage

firm telephoned the Inquirer each afternoon with the closing calculations for
the index, the total number of shares traded for each of the index stocks, and
any unusual activity in these stocks. This proceSs had been going on for over
fifty years, and both the brokerage firm and the newspaper appeared satisfied
with the arrangement. V

Henry had taken a course in investments while in college, and he was fa-
miliar with the calculation procedures for the popular market measures such
as the Dow Jones averages and the Standard 81 Poor’s indexes. Upon being given
this assignment, Henry had asked Mr. Law how the-Oil Index was calculated.
Law did not know and suggested that Henry call Iack Gamble at the broker-
age firm. Gamble reported that the index was calculated in exactly the same
manner as the Dow Jones averages—all capitalization changes were handled
on a divisor-adjusted basis. On December 31, 1987, the divisor for thewindex
was 1.4238, and changes in the diVisor occurred only with . capitalization
changes affecting 10 percent or more of a firm’s outstanding shares.

Henry recalled that his college professor had pointed out a number of weak-
nesses in the Dow Jones averages and had seemed to prefer value-weighted arith-
metic indexes, such as those calculated by the Standard & Poor’s Corporation
(S&P). In reviewing his notes from the investments class, Henry found the gen-
eral formula for the S&P Industrial Index: '

tub—A ‘

h—l

s-anHD-alfifltn
THE MIDLAND INQUIRER ' i l i 7 17

5.. (current market pricei X current outstanding shares,) X

(1941—43 average X 1941—43 average

market pricei outstanding sharesil

10

Henry recalled that a change in the denominator, or old base-market value, oc-
curred only with a change in capitalization. The professor had given the class a
formula for calculating the new base-market value:

market value as of base date,

reflecting the change in
capitalization
market value as of- base date,
before the change in
capitalization '

old base-market value X

= new base-market value

Henry decided to experiment with a new index of petroleum refining com-

panies calculated in the same way as the S&P Industrial Index. First he expanded
the number of companies in the index from 7 to 20. The names of the 20 com-
panies, the share prices, and the number of shares outstanding are shown in
Table 2.2. Henry thought that if he used December 31, 1986, as the date for the
original base-market value and assigned the index a beginning value of 50 (the
approximate average price of the 20 securities on that date), he would be able to
produce a better measure of performance than the current index.
I QUESTIONS

1. What are the major arguments against the use of the Midland Inquirer Oil
Index as a measure of the performance of petroleum refining companies? What
are some arguments in favor of the continued use of this measure?

2. Why did the index divisor decline from its beginning value of 7 to 1.4238 by
December 31, 1987?

3. What are the advantages and disadvantages of Henry’s new index relatiVe to'
the present index? '

4. Assuming no changes in capitalization between December 31, 1986, and

March 30, 1987, calculate the values for the Inquirer Oil Index and Henry’s
proposed index on December 31, 1986, and March 30, 1987. Compare the per-
centage changes in the two performance measures between December 31,
1986, and March 30, 1987.

8 THE INVESTMENT ENVIRONMENT

TABLE The. Mid/and Inquirer —

2.1 Typical Oil Index Column -

Oil Equities Up 2.75

Oil stocks advanced 2.75 Thursday in heavier trading with two issues advancing,
two declining, and three unchanged. ' i ' Fl”

The Midland Inquirer Oil Index closed at 206.64. Total volume for the seven 8 c
stocks in the. index was 994,344 shares, compared with' 1,341,200 the previous
session.
Mobil gained two points, closing at 391/2, while Murphy Oil gained one point t
to 27. , » .

Texaco traded 354,000 shares; Murphy Oil, 49,244; Standard Oil, 175,400; Exxon,
147,400; Phillips Petroleum, 132,100; Atlantic Richfield, 74,100; and Mobil, 62,100.

TABLE The Mid/and Inquirer

2.2 Petroleum Refining Companies

Share Shares 1 Share

Price Outstanding Price
Company 12/31/86 12/31/86 (0001 3130/87
Amerada Hess Corp. 23% 83,063 31%
Ashland Oil Corp. 56‘ 32,541 593/4
Atlantic Richfield1 60 176,473 _ 80
British Petroleum Co., Ltd. 431/2 182,857 591/8
Chevron Co. (Calif)l 453/8 342,109 56%
Exxon Corp.‘ * 70% 722,155 85%
Kerr-McGee Corp. 281/8 ' 48,358 345/3
Mobil Corp.‘ I 401/8 ‘ 408,239 47%
Murphy 011 Corp.‘ 25 33,591 33
Pennzoil Co. 67 41,426 79%
r Phillips Petroleum Co.1 11% 227,883 157/3
Quaker State Oil Refining 25 26,335 281/4
Royal Dutch Petroleum Co. 951/2 268,037 1177/8
Shell Transp./ Trading 581/2 276,209 V 803/8
Standard Oil Co. 49% 234,685 701/4
Sun Co. 541/4 107,712 68% '
Tesoro Petroleum Corp. 10% 13,731 12%
Texaco, Inc.l , 357/8 241,474 37%
Unocal 26% 116,305 37 1/s
Witco Chemical Corp. 385/8 22,231 447/8

‘Included in the currently published Midland Inquirer Oil Index.