Making a series of new lows, the Dow Jones Industrial Average seems to have no support from a technical point of view, but if you pick through the 30 members I think the upside here far outweighs the downside.
If the 15 smallest-weighted DJIA stocks plummeted to zero, that would wipe out about 22% of the index, which to me actually sounds bullish. Among those 15 – thanks to the Dow’s methodology – are Microsoft (MSFT), Intel (INTC), Kraft (KFT) and AT&T (T), just to name a few. The point being, there are not 15 Dow stocks headed to zero. Citi (C) and GM equity is likely worthless, but that amounts to less than 1/2 a percent of the index, or 31 points. Wipe out “leveraged blue-chips” GE and Alcoa (AA), and BofA (BAC), and the index loses a combined 2.5% or 177 points, an afternoon’s work for the Dow as of late.
Using 10 year average EPS, the Dow trades at a weighted multiple of 16 – a level that argues for sub-par returns going forward, as demonstrated by Yale’s esteemed Robert Schiller. However, largely impacting that are CVX and XOM, whose earnings are up eight and eleven-fold. While a decline in profit for these stocks will be in order, they’re not headed back to 1.00 per share in earnings, and their mini-PE’s discount the earnings drop. IBM trades at a trailing 9 times earnings, and PG and JNJ trade around 12 times both forward and trailing estimates – amazing values for these best-of-breed companies. The Dow stocks trade, on average, at a 63% discount to 10 year their average trailing PE ratios. There are numerous potential double’s and triples in the Dow, including HPQ and BA at 8 and 9 PE’s.
Leaving aside PE’s, the Dow 30 is attractive on a Free Cash Flow basis as well, with the top two stocks’ FCF yielding 11 and 12% of their (net of cash) Market Caps. I’m not one to ignore debt in the capital structure, but the interest coverage ratio’s of the Dow stocks are lavish – the top 83% of the index has an average EBITDA/Interest ratio of 49, thanks to the oil majors.
There is some serious garbage stinking up the Dow, but thanks to the index’s price-weighted methodology, their damage has largely been done. Meanwhile, great companies can be had at great prices by owning this index, and I think the future will reward those who put money to work at this level.
Disclosure: Author is long DIA.
