What it is:
The mean is the average of a series of numbers.
How it works (Example):
The formula for calculating a mean is:
Mean = (X1 + X2 + X3 + ... +XN) / N
where X1, X2, X3, XN are the values of the observations being averaged and N equals the number of observations
Let's assume that you would like to find the mean price of Company XYZ for the last four years. Here are the stock prices for each of the four years:
Year 1: $10
Year 2: $15
Year 3: $20
Year 4: $25
Using this information and the formula above, we can calculate that the mean price of Company XYZ is:
($10 + $15 + $20 + $25) / 4 = $17.50
The mean is always between the smallest and the largest of the numbers in the set.
Why it Matters:
The mean allows investors to gain some insight into stock prices, economic data, and a host of other information. For instance, if Company XYZ's stock price is trading above the mean, it could indicate that the stock is overvalued.
It is important to note that means are not very useful if the underlying data is erratic. That's because one "outlier" could artificially increase or decrease a mean to a point where it is no longer reflects the nature of the bulk of the underlying data. This is one reason some analysts prefer to use weighted averages in certain circumstances.