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Performance Studies on the DJIA, Fundamental Value Stocks

Posted on | November 22, 2008 Time: 2:11 pm |

Friday morning I wrote a commentary piece for Investopedia that discussed the current metrics of the DJIA. Some of the metrics for the Dow Jones 30 have been misquoted in the past week, such as the current price/sales ratio. I heard several people say the P/S on the DJIA was 0.7 last week, which just isn’t true. It might be 0.7 if General Motors (and its 0.01 P/S ratio) didn’t comprise just 0.33% of the index, but it does.  A weighted average P/S ratio of 1.21 is what I came up with as of Thursday’s close.

The current Price/Book measure is not so special historically, coming in at 2.53. Much of this is due to the recent shakeup in stock prices - higher P/B companies like McDonald’s, IBM, and 3M are now huge components of the DJIA, while larger companies with lower stock prices now have minimal weightings in the index (think Bank of America at 1.2%, GE at 1.35%, Intel at 1.3%).

The current P/E on the Dow is right around 10.5x trailing earnings, while the forward measure is currently 9.59 times…but the latter is surely expected to rise. As we’re all aware by now, individual company estimates for 2009 are still drastically high in many cases; I wouldn’t be surprised if revisions alone pushed the forward measure up into the 13-14 level.

The good news about P/Es (useless as they have been lately) is that looking over the massive Shiller data for the S&P 500, there are really only two time periods in the past century that saw lower valuations on equities. The first was, naturally, during the initial Great Depression years of 1932-33. The second was in the hyperinflation days of the early 1980’s, when 12% rates absolutely crushed forward cash flow estimates, and subsequently stock valuations.

As I stated in my commentary,

…we’re in a low-to-no inflation world, so the early 80’s valuation precedent (where Treasuries yielded 14%) shouldn’t be able to replicate itself today…and the events leading up to the Great Depression remain an outlier that should never be repeated, simply due to the force and direction of government and monetary responses seen today.

And as to ole’ “GD” - well, if we’re headed there again, then yes, lower we can certainly go on the Dow. But anything short of that level of crumbling, and stock valuations are objectively as attractive as they’ve been in 50 years.

Earnings Yield at a Record?

It sure looks like the spread between the equity earnings yield and treasuries is at an all-time high. Using the trailing P/E figure, we’ve got a current earnings yield of about 9.5%, compared to benchmark treasury yields and just over 3%. that’s 600 basis points of spread, a nearly incomprehensible figure. And one that implies a helluva large margin of safety around the risks inherent in stocks right now.

Obama Realizes

Thank goodness President-Elect Obama is aware enough to realize how important his continued interactions with the market are right now. The prospect of a two month black hole in our “financial backstop team” (I refuse to call it leadership until they lead) was a hard pill for markets to swallow, and fear levels rose dramatically ever since Paulson told markets that the TARP wouldn’t be used to buy up toxic loans and securitizations.

Obama released a statement & address this morning that calls for an ambitious job creation plan. Obama’s plan calls for an infrastructure stimulus plan to be signed shortly after entering office in January. We’ve known about his plans for infrastructure stimulus for a while now, but hearing some real targets and dates put around it should add provide some sentiment tailwinds heading into next week.

Our late-day rally of over 5% in the major indexes Friday came largely on the news that Tim Geithner was selected as the next Treasury Secretary. Geithner had been the front-runner, but spike in the markets to close the day shows just how sensitive the market is to actual facts, whether good, bad, expected, or not.

Geithner will be a fine choice, mainly because his career highlights all involve crisis - from LTCM, to the Mexican peso collapse, to the Asian Crisis of the early 90’s, to Bear Stearns in 2008. Call him Dr. Doom if you want, but the man is intelligent, and he’s helped to write the modern playbook on dealing with financial crises. This link will take you to a good background piece on Geithner written earlier this year, before he was unfairly labeled “part of the problem” by some because of his role in navigating the current crisis.

Inside the Numbers, Part 3

I ran another relative performance screen on my deep value set, as defined in my earlier posting (”Inside the Numbers Redux; Why We (Likely) Haven’t Bottomed Yet“). The results were very encouraging, albeit run with a narrower aperture. 67 stocks in the S&P 500 passed the screen Friday, and 29% of those were up over 10% on the day. Only 24% of the S&P as a whole did the same. The month-long trend had been the stocks with the lowest valuations and strongest balance sheets underperformed the benchmark index.

On the other end, 48% of the filtered group were down more than 10% on the week, versus a slightly larger 53.5% for the S&P as a whole. This certainly isn’t long or strong enough to signal a trend, but it is a sharp reversal from the results seen in the first two iterations (see the Inside the Numbers from 10/23).

Ryan Barnes

More on this topic (What's this?)
2010 Dogs Of The Dow Performance Update (Disciplined Approach to Investing, 2/18/10)
DJIA Daily Trading Model (All Allan, 2/12/10)
One Indicator That’s Unquestionably Bullish (Money Morning, 2/5/10)
Read more on Dow Jones Industrial Average (DJI), Price to Sales at Wikinvest
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