|
Published: October 14, 2009
Financials had a good day yesterday and the Dow
hit 10,000 for the first time in a year.
That's the news.
Now for the question: Will it last?
Most probable answer: No.
Some will certainly disagree. After all, we all know the adage
about bull markets climbing a wall of worry. And a cursory
glance at the Industrial Average does indeed suggest there is a
lot of room for upside.
The Dow trades at 14.5 earnings, a little less
than its five-year historical average of 16.5 times earnings.
And the index has ranged as high as 21.7 times earnings in that
period, a level of valuation that would, if applied equally to
the Average's constituents, elevate the Blue Chip Index to
13,585 -- nearly the 14,000 level it briefly reached pre-crash,
about a year ago.
But if you take the index apart
and put it back together, logically
examining each piece, the picture is
a little less rosy. The Dow, based
on historical average valuations and
current 2009 EPS estimates, should
end the year at 9,786.83, about a
-2.3% drop from today's levels.
If that helps your index option
trading, I'm glad.
But let's not stop there. Let's see
what it means for the 30 individual
stocks that make up the index.
The Dow is being lead by 12 stocks
who are selling at historically rich
valuations, notably Bank of
America (NYSE: BAC), at 109
times trailing twelve-month
earnings. The chart below shows the
companies that are trading at above
their five-year average earnings
multiple.
|
 |
The trick here, in my view, is not to see who's overvalued --
who not to buy -- but who has still has a chance to tack on some
gains based on their likely 2009 results.
That leaves 17 potentially undervalued companies. (Alcoa
(NYSE: AA), which has a net loss for the past 12 months, is
excluded from both lists.)
Here are those companies, sorted by relative historic
undervaluation.
|
 |
General Electric (NYSE: GE) strikes me as the clear
and obvious pick from this list. The company's diverse mix of
business units makes it a proxy for the overall U.S. economy. If
we accept general market movement as a reasonably accurate
leading indicator of the economy, then GE may well have the most
to gain as conditions improve across the board, even if current
valuation, historical valuation and earnings estimates point to
a slight -2.3% correction to the Dow.
Below, the chart gives the 30 Dow components and their Oct. 14
closing prices and then calculates the Dow Jones Industrial
Average using its current divisor. The "Fair Value" column is
the result of each companies EPS estimate times its five-year
average earnings multiple. The column uses an adjusted divisor
-- so as to exclude Alcoa -- to suggest the index's year-end
value.
-- Andy Obermeuller
Chief Investment Analyst
Government-Driven Investing |
