Hi Donald, below is some info on the VLA and the VLG which you were also asking about.
If you want you can go to the site and register for free and review information about there indicies.
valueline.com
John
Comparing the
Value Line Indexes
Reprinted from the September 25, 1998 issue of
the Value Line Investment Survey ® Selection & Opinion
We receive many inquiries from our subscribers regarding the differences
between the Value Line Composite (Geometric) Index and the Value Line
Arithmetic Index. In response, we are partially reprinting and updating an
article that first appeared in Selection & Opinion on December 10th, 1993.
On June 30,1961, we introduced the Value Line Composite Index (VLG). This
index assumes equally weighted positions in every stock covered in the Value Line
Investment Survey; that is, it is presupposed that an equal amount of dollars is
invested in each and every stock. The VLG is averaged geometrically every day
across all the stocks in the index, and consequently, is frequently referred to as
theValue Line Geometric Index. The VLG was intended to provide a rough
approximation of how the median stock in the Value Line Universe performed.
Calculating Value Line Indexes
The VLG is calculated in the following manner: 1) For each stock, compute the
ratio of its closing price today to the close on the previous trading day (e.g., if IBM
goes from 130 to 135 in one day, its ratio is 1.038, but if AT&T goes from 58 to
55, its ratio is 0.948); 2) Multiply all of these ratios together; and 3) Raise this
quantity to the power defined by the reciprocal of the number of stocks in the index
(usually this is a number between 1600 and 1700). The result is the ratio of today's
VLG price to the previous trading day's close. To derive the percentage price
change, subtract 1 from this value and multiply by 100.
On February 1, 1988,Value Line began publishing the Value Line Arithmetic Index
(VLA) to fill a need that had been conveyed to us by subscribers and investors.
Like the VLG, the VLA is equally weighted. The difference is the mathematical
technique used to calculate the average price change of stocks in the index.
The VLA is calculated in the following manner: 1) Compute the ratio of every
stock's price change the same as in the first step of the geometric calculation; 2)
Sum all of the ratios together; and 3) Divide the total by the number of stocks. The
result is the ratio of today's VLA price to the previous trading day's close. Again,
to get the percentage price change subtract 1 from this value and multiply by 100.
A more visual display of these calculation methodologies appeared in the March
25, 1988 Supplement section of the Value Line Investment Survey. (Copies are
available upon request.) Upon VLA's introduction in 1988, the index values were
computed on a daily basis back five years to the beginning of 1983 to provide an
historical frame of reference.
Differentiating the VLA and VLG
The VLA provides an estimate of how an equal-dollar-portfolio of stocks will
perform. Or, put another way, it tracks the performance of the average, rather than
the median, stock in the index. It can be proven mathematically that the maximum
daily ratio attainable by the VLG is equal to the daily ratio of the VLA. However,
this special case can only occur when every single stock in the index has the exact
same percentage price change on a given day—a highly unlikely scenario. For all
practical purposes then, the daily percentage price change of the VLA will always
be higher than the VLG.
The systematic understatement of returns of VLG is a major reason that the VLA
was developed. The wide-ranging coverage of the Value Line Investment Survey
and its equally weighted nature made the VLG very appealing conceptually as
representative of a typical retail investor's portfolio; VLG also has appeal to
institutional investors as a proxy for the so-called "mid-cap" market because it
includes large cap, mid-cap, and small cap stocks alike. Because of this interest,
the Kansas City Board of Trade instituted trading in Value Line Index Futures in
1982. However, the performance of the VLG over time proved to underestimate
the performance by too large a factor. For example, for the three-year period
ending December 31, 1989, the VLG had an annualized price change of 4.7% in
comparison with 12.6% for the VLA and 13.4% for the S&P 500 Index.
Accordingly, it was easy to "game" the early Value Line futures with a
representative basket of the underlying securities, since the basket would always
outperform the VLG. The VLA price changes are much closer to the returns that
would be derived by the underlying basket.
Moreover, while the differences between daily price changes may seem small, the
magnitude of the annual differential between the two indexes is prodigious.
The bar graph below shows that for the past ten years ending year-end 1997, the
differences between the annual price change between VLA and VLG average
approximately 740 basis points. The difference is only slightly smaller for the three
shorter time frames. Alternatively, it can be argued that the VLA somewhat
overstates returns of the equally-weighted basket of stocks since it does not assess
the transaction costs that would be entailed by following the strict discipline of daily
rebalancing to bring the portfolio back to equally weighted positions. However, our
research shows that calendar year quarterly rebalancing closely tracks index
performance while mitigating transaction costs.
Other Major Indexes
How does the VLA differ from the two most popularly quoted indexes: the Dow
Jones Industrial Average (DJIA) and the S&P 500 Index? There are two major
differences: the weighting scheme and the number of stocks. The S&P 500 is
weighted by market capitalization. As such, stocks with large market caps account
for much of its monthly price fluctuations. This fact accounts for the large disparity
between the S&P 500 and VLA benchmarks so far this year. Although at August
31, 1998, both indexes were below their beginning marks for the year, the S&P
500 was much in much better shape than the VLA (-15.4% for the VLA vs.
-1.36% for the S&P), reflecting investors' preference for large, liquid stocks.
Indeed, an issue such as General Electric, whose market cap is quite large, will
have a much greater proportionate effect on the S&P 500 than on the equally
weighted VLA. One or the other may be more appropriate, depending upon one's
goals, but the user should be aware of the differences. Finally, the VLA is much
more comprehensive, including all of the companies in the S&P 500 along with
almost 1,200 other companies of interest to our subscribers. Nevertheless, more
comprehensive indexes than our arithmetic index, such as the Russell 3000, also
exist, providing even a broader view of market performance.
COMPARING THE VLA AND THE S&P 500
% Price Change From Previous Year
Year
Value Line
Arithmetic
S&P 500
1988
22.66%
12.40%
1989
18.23%
27.25%
1990
-16.75%
-6.56%
1991
38.83%
26.31%
1992
15.14%
4.46%
1993
18.07%
7.06%
1994
-0.73%
-1.54%
1995
25.94%
34.11%
1996
19.78%
20.26%
1997
28.45%
31.01%
The Dow Jones Industrial Average is valued mostly for its long history and its
simplicity. It consists of only 30 stocks—all of which are included in the
VLA—and it was originally designed for easy computation on the back of an
envelope. This index is weighted by the price-per-share of each of its component
stocks. That is, a 10% gain in a stock that sells at $90 influences its price
movements three times as much as a 10% gain in a $30 stock. In truth, there is no
rational justification for such a weighting scheme other than that it was simple to
compute before computers were available. Moreover, few investment professionals
would consider any basket of 30 stocks to be representative of today's U.S. stock
market. Nevertheless, it is useful to understand these differences because the DJIA
is still the single most frequently quoted barometer of market performance.
After more than ten years since its inception, we still get many questions on the
VLA, and continue to learn more about its behavior. The fact that interest in it
continues to be expressed underscores its value as a measurement tool.
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