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Published: July 18, 2009
Everything is relative,
especially market valuation.
A utility, for instance, with its steady, slow-growth business,
is never going to command the earnings multiple of a rapidly
growing biotech firm or high-tech upstart. That's why it's best
to make valuation comparisons within industries.
It's also reasonable to evaluate a company against an index. For
instance, the composite earnings multiple -- that is, the P/E
ratio -- of the 30 stocks that make up the blue-chip Dow Jones
Industrial Average is 11.6.
In other words, the combined market capitalization of these
companies is 11.6 times the profits they have generated in the
past 12 months. Or you could say that a dollar of earnings costs
$11.60.
It doesn't make much sense to
compare the Dow to anything other
than its past performance. The Dow
is now at about 8,700, far from its
late-2008 peak near 14,000. That
means the prices that factor into
that market cap have fallen. That's
been offset by an overall declined
in earnings since the Great
Recession began. Both of those
things have affected the aggregate
valuation of the index, which is now
-23.4% lower than it was two years
ago, when the Dow's P/E was 15.18.
If a Dow company's valuation
relative to its earnings has fallen
by more than the Dow, that suggests
upside potential. Earnings and
prices are likely to return to their
historical norms.
Here's a look at the Dow, excluding
Alcoa, which has posted a net loss
for the past 12 months and, as such,
has no earnings multiple. Note that
only stocks that are undervalued to
their typical valuation are included
in the table.
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The most undervalued company is General Electric (NYSE: GE).
The Connecticut-based conglomerate, given its reach of its
business units, is a proxy for the American economy. It's a
strong long-term buy for three reasons:
GE not only has a diverse product lineup, but many of its
offerings are in line with key administration policies for clean
energy, digital medical records and upgrading the nation's
electric grid. Washington is committing hundreds of billions to
these areas, and GE is the No. 1 or No. 2 player in each.
The company can be expected to deliver profits of between $1.92
and $2.26 a share in a good economy, earning about a 10% net
profit margin. Though its take for the first two quarters is
about half its typical results, that's because of broader
economic concerns, not any significant problems with GE. Buy GE
for the next two years. Don't overlook it because of the past
two quarters.
GE has a history of managerial excellence. Jeffrey Immelt may
not have the star power of Neutron Jack Welch, but he's been a
steady hand during turbulent times. There are two reason Warren
Buffett invests: A good business and management he trusts. GE
has both. And not only is Buffett a shareholder, he also lent
the company $3 billion by purchasing $3 billion worth of
preferred shares in October 2008.
On top of those three reasons, GE has historically paid a modest
dividend (currently a little more than 3%). You don't even need
a broker: Investors can buy shares
direct. The account
requires an initial investment of $250 and allows for additional
purchases of as little as $50, which can be automatically
deducted from a checking account.
-- Andy Obermeuller
Chief Investment Analyst
Government-Driven Investing |
