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Stock Market Basics

The stock market isn’t a casino. See the actual math behind share prices, P/E ratios, and why dollar-cost averaging works.

401(k) Limit 2024$23,000(+$7,500 catch-up 50+)

Roth IRA Limit$7,000(MAGI phase-out applies)

S&P 500 Avg Return~10%/yr(nominal, historical)

The stock market isn't a casino — here's the actual math behind it. A share represents partial ownership of a real business with real earnings. Understanding P/E ratios, earnings yield, and compounding is the foundation of every sound investing decision.

P/E Ratio Simulator

How expensive is a share relative to its earnings?

Share Price ($)

Earnings Per Share (EPS)

P/E Ratio

25.0x

S&P 500 Avg

25x

Long-run historical average

Earnings Yield

4.00%

Return per $ invested

Valuation signal:Fair

P/E vs S&P 500 Average (25x)

0x25x (S&P avg)50x+

Earnings yield is the inverse of P/E. A P/E of 25.0x means you earn approximately 4.00% in earnings for every dollar you invest. Compare this to bond yields to judge relative value.

Historical Examples

What $1,000 became — illustrative approximate returns

AppleAAPL

Since 2014

Invested$1,000

Current value$9,200

Implied annual~20%/yr

S&P 500 Index FundSPY

Since 2014

Invested$1,000

Current value$3,800

Implied annual~14%/yr

AmazonAMZN

Since 2014

Invested$1,000

Current value$7,100

Implied annual~19%/yr

Illustrative examples based on approximate historical returns. Past performance does not guarantee future results.

Index Funds vs. Active Management

The math of fees compounds against you

85% of actively managed funds underperform the S&P 500 over 10 years (SPIVA data). The math of fees compounds against you — even a 2% annual expense ratio quietly erodes a significant portion of your wealth over decades.

Index Fund (10%/yr)

0.03% expense ratio — S&P 500 ETF

$67,275

$10,000 over 20 years

Active Fund (8%/yr net)

2% expense ratio drag applied

$46,610

$10,000 over 20 years

Difference: $20,665 lost to fees over 20 years on a $10,000 investment.

Dollar-Cost Averaging Simulator

DCA vs. investing a lump sum upfront

Monthly Amount ($)

Annual Return (%)

Years

Lump Sum ($)

Dollar-Cost Averaging

Final Balance$20,655

Total Contributed$12,000

Investment Gain+$8,655

DCA Running Balance — First 12 Months

Mo 1$1,257

Lump Sum Upfront

Final Balance$3,112

Total Contributed$1,200

Investment Gain+$1,912

Full capital works for all 10 years from day one, maximizing compound time.

DCA reduces the risk of investing at a peak — you buy more shares when prices are low. Lump sum statistically wins more often when markets trend upward, but requires more conviction and timing tolerance.

P/E Ratio

P/E = Share Price ÷ Earnings Per Share

150 ÷ 6

= P/E = 25.0

A P/E of 25 is roughly the long-run S&P 500 average. Below 15 is often considered cheap; above 30 may signal high growth expectations.

Earnings Yield

Earnings Yield = (1 ÷ P/E) × 100

(1 ÷ 25.0) × 100

= 4.00%

Earnings yield is the inverse of P/E — it tells you what return you get in earnings for each dollar invested. Useful to compare against bond yields.

Market Cap Concept

Market Cap = Share Price × Shares Outstanding

e.g. $150 × 15.4B shares

= e.g. $2.31 Trillion

Market cap is the total market value of a company. A share price alone tells you nothing about size; market cap is the real measure.

Dollar-Cost Averaging (DCA)

FV = PMT × ((1 + r)ⁿ − 1) / r × (1 + r)

PMT = $100/mo, r = 0.00833/mo, n = 120 months

= $20,655

This is the future value of an annuity-due formula. Each monthly contribution compounds for the remaining periods.

Lump Sum Growth

FV = P × (1 + r)ⁿ

$1,200 × (1 + 10%)^10

= $3,112

Investing a lump sum earlier gives the entire amount more time to compound. Statistically it beats DCA ~2/3 of the time, but DCA reduces peak-investment risk.

Compound Return on $1,000 Historical Example

FV = $1,000 × (1 + r)^n

$1,000 × (1 + 20%)^10 (Apple illustrative)

= ≈ $6,192

Illustrative only — based on approximate historical returns. Past performance does not guarantee future results.

Illustrative historical example

Key insight

The most powerful force in investing is compound growth over time. A single percentage point difference in annual return becomes enormous over 20-30 years — which is why index fund fees matter far more than most investors realize.

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