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Bill Freehling is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Bill Freehling.

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Why the fuss over Dow 11,000?

Related: Who is baseball’s best pitcher?

THE DOW JONES Industrial Average’s quest to break 11,000 points had financial news networks all worked up this past week.

 ”Dow Industrials Hit 11,000 for the First Time Since Early May,” screamed a post labeled “BREAKING NEWS” on CNBC.com late Friday morning.

 (The headline was actually not correct, as the Dow crossed above 11,000 earlier this week before closing below that mark. But that’s not really the point, which I’ll get to shortly.)

The Dow last closed above 11,000 in early May. By the end of that month, however, it was back below 10,000–a roller-coaster trend that has been occurring all year and may well again this time.

It’s amazing how psychologically important round numbers such as 11,000 are to investors and commentators. It even seems to affect trading, as evidenced by the Dow’s bouncing above and below the mark all week.

 In reality there’s nothing magical about round numbers such as 11,000. To put it in perspective, the Dow first hit 11,000 more than a decade ago, and it’s still more than 20 percent below the all-time highs of October 2007.

Further, though the 30-stock Dow is commonly equated with how “the market is doing,” in reality it’s not even the index that most professional money managers pay most attention to. That’s the Standard & Poor’s 500, which is usually the benchmark against which money managers are measured. It has been shown, though, that Dow and S&P 500 returns are largely correlated, due in large part to the fact that the Dow stocks include a sizable portion of the S&P 500′s market cap.

Such rationality aside, round numbers such as 11,000 will likely continue to dominate commentators’ stock market focus.

Using the right numbers

Warren Buffett frequently counsels investors to look at the right numbers when considering stocks. He says there are usually a couple of key, simple indicators that identify successful firms for every industry. He said these pop out in annual reports if you know where to look.

Sadly, few people know where to look (otherwise we’d all be as rich as Buffett). And Buffett isn’t telling us.

Though I can’t offer much on identifying the right numbers to look at when judging stock investments, I believe I do have some insight on picking apart baseball numbers. This skill was gleaned from a decade of doing fantasy baseball (which I quit this year in order to pursue a real life) and reading voraciously on that sport’s statistics.

Roy Halladay’s no-hitter this past week for the Phillies inspired me to run the numbers for 2010. Research has shown that pitchers can essentially control only four things: home runs allowed, hit batsmen, walks and strikeouts. Everything else is dependent on defense. Dividing strikeouts by the other three categories offers a true gauge of a pitcher’s skill, and it predicts performance in future years better than flawed stats such as earned run average.

To find the best hitters, look at on-base percentage plus slugging (OPS). That stat can be easily looked up on sites such as MLB.com, and this year identifies Josh Hamilton, Miguel Cabrera, Joey Votto and Albert Pujols as the league’s top hitters.

My pitching calculation requires a little more effort, but I’ve done the work for you. It’s on my Business Browser news blog on freder icksburg.com. Hint: Halladay was only the second-best pitcher in baseball this past year, according to this calculation.

Now if only I could figure out those key numbers Buffett is looking for.

Permalink: http://news.fredericksburg.com/businessbrowser/2010/10/10/why-the-fuss-over-dow-11000/

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