The new record high for the Dow Jones Industrials Average (DIA) is a good time to analyze the components that make up the index. This article analyzes the EPS estimates for each of the 30 components in the Dow Jones Industrials Average from a few angles, including recent changes in analyst forecasts, implied growth rates and P/E and PEG valuation metrics.
The last time that we published an analysis like this was on September 3, 2012 (Dow Jones Industrial Average Is Rallying Despite Cuts In Forward EPS Estimates). Compared to the September analysis, there have been less reductions in forward earnings over the last quarter. Furthermore, growth rates and valuation multiples to continue to be reasonable. The Dow Jones Industrials Average may rise or fall in the short term, but it does seem to have a good fundamental foundation and reasonable expectations going forward.
EPS Changes Over The Last 90 Days
Investors and analysts were encouraged by the Q4 earnings season, which started in January. However, over the last quarter the number of DIA components with upside and downside EPS changes was roughly even. EPS estimates were raised for 47% and 53% of the DIA components for FY1 and FY2 (the next one and two fiscal years). Although this may not seem like much, in September 2012 the majority of DIA components experienced EPS cuts over the prior quarter.
The following table displays the changes in EPS estimates for the upcoming two quarters and upcoming two fiscal years over the last 90 days.
(See "Notes" section below for definitions of FQ1, FQ2, FY1, FY2 and other information)
Forecasted Revenue and EPS Growth
The current forecasts seem to imply reasonable revenue and EPS growth for the DIA components. For FY1, the median forecast for revenue growth is 3% and the median EPS growth estimate is 8%. The forecasts for FY2 are slightly more positive, with median revenue growth of 5% and median EPS growth of 10%. These forecasts seem reasonable assuming that U.S. GDP can grow >2% in 2013 and ~3% in 2014.
Some analysts and commentators have argued that margins have peaked, but I believe that many companies can still achieve higher margins. Furthermore, the EPS numbers will continue to benefit from large buybacks by some of the DIA components.
It is possible that analysts will cut their forecasted growth rates further, but I would expect such cuts to be limited as the current forecasts seem reasonable in aggregate.
(See "Notes" section below for definitions of FQ1, FQ2, FY1, FY2 and other information)
According the DIA website, the trailing P/E multiple for the DIA is 14.45x and the FY1 forward P/E multiple is 12.63x (these numbers are weighted). On an unweighted basis, the average FY1 P/E multiple is 13.0x and the average FY2 P/E multiple is 11.8x. Back in September, FY1 represented the estimates for 2012 for most of the DIA components and now it represents the estimates for 2013. Interestingly, the current FY1 multiple is roughly where it was in September, which should give optimism to the bulls that believe in a continued rally for the DIA.
The second chart below shows the PEG ratios for each of the DIA components. PEG is defined here as FY1 or FY2 P/E over the estimated EPS growth rate for that year. The next section compares some of the DIA components on this metric.
(See "Notes" section below for definitions of FQ1, FQ2, FY1, FY2 and other information; green shading indicated greater than median and red shading indicates less than median)
DIA Component Highlights
Some of the DIA components stand out when looking at these tables.
Boeing (BA) is one of the strongest companies in the DIA in terms of positive changes to EPS estimates and the expected EPS growth rate. Boeing's strength in these metrics comes at a time when it is suffering through the Dreamliner grounding and looming defense cuts due to the sequester and the potential for additional defense budget cuts. Over the last 90 days, Boeing's EPS estimates increased 15-29% for the time frames analyzed above. Furthermore, EPS is expected to increase 25% in FY1 and 13% in FY2, which makes Boeing one of the companies with the strongest EPS growth rate in the DIA. Despite this growth, Boeing's P/E is below the median for the DIA components. (I do not follow Boeing closely, but will now take a closer look considering this information.)
Investors seem to value the "defensive" DIA components with the relatively high P/E multiples despite relatively low EPS growth. The following companies have some of the highest PEG ratios of all the DIA components and they all have P/E multiples above the median:
- Procter & Gamble (PG) - PEG of 3.46 (5% EPS growth, P/E of 18.9x)
- Coca-Cola (KO) - PEG of 2.80 (6% EPS growth, P/E of 18.1x)
- Wal-mart (WMT) - PEG of 2.15 (6% EPS growth, P/E of 13.7x)
- McDonald's (MCD) - PEG of 2.05 (8% EPS growth, P/E of 16.4x)
IBM (IBM), one of the steadiest companies in the DIA, is projected to grow EPS by 10% in FY1 and FY2, but only has a FY1 P/E of 12.2x (slightly below the median).
I wonder how long the defensive stocks - Procter & Gamble, Coca-Cola, Wal-Mart, McDonald's - will be able to maintain relatively high PEG ratios. Understandably, investors have been paying up for defensive stocks over the last few years, but I wonder if the divergence between relatively low EPS growth estimates and relatively high P/E multiples can be sustained.
Finally, Caterpillar (CAT) stands out as one of the relative underperformers in this analysis. Over the last 90 days, Caterpillar's downward EPS revisions were the most pronounced of all the DIA components. Analysts cut their EPS estimates for Caterpillar by 20%, 4%, 7% and 5% for FQ1, FQ2, FY1, and FY2, respectively. Furthermore, Caterpillar's EPS is expected to decline by 10% in FY1. Caterpillar is one of the DIA components that is most reliant on global growth and is a "risk-on" stock. Its relative earnings underperformance is an important signal about the strength of the market going forward.
EPS Estimates in Perspective
It is important to note that analysts are often too bullish on companies in the long term (extrapolating recent performance without forecasting future downturns), but undershoot earnings in the short term to allow companies to show an earnings beat. The future cannot be predicted precisely and analyst estimates have their own limitations. Nonetheless, changes in analyst estimates can be an interesting sentiment indicator and serve as one of many tools in market analysis.
Please note a few risks and considerations. This analysis is not helpful for short term traders or very long term investors. Also, the price movements of stock or ETF may not follow fundamentals for long periods. Lastly, changes in the broad economy, actions by the Federal Reserve or another crisis in Europe could divert investor attention away from company earnings.
Now that the Dow Jones Industrials Average is at a record high, the question is where does it trade from here. Analyst sentiment with regards to EPS estimates is somewhat better than it was several months ago. Furthermore, the analyst community seems to have reasonable assumptions for revenue and EPS growth for the DIA components in aggregate. Finally, despite the recent rally, forward valuations are in-line with the recent past. These ingredients provide a good foundation for the DIA to continue to rise from its new record high.
The mean and median figures presented in this article represent the unweighted mean and median of the metrics for the 30 components in the Dow Jones Industrials Average and are not price-weighted like the index itself.
Earnings Estimates are based on data from Yahoo Finance as of March 5, 2013.
FQ1 and FQ2 refer to the fiscal quarter ending in March 2013 and June 2013, respectively, and FY1 and FY2 refer to the fiscal year ending December 2013 and December 2014, except for the following companies: Procter & Gamble (March 2013, June 2013, June 2013, June 2014), Wal-Mart (April 2013, July 2013, January 2014, January 2015), Home Depot (April 2013, July 2013, January 2014, January 2015), Disney (March 2013, June 2013, September 2013, September 2014), Microsoft (March 2013, June 2013, June 2013, June 2014), Cisco (April 2013, July 2013, July 2013, July 2014) and Hewlett-Packard (April 2013, July 2013, October 2013, October 2014).
Disclosure: I am long BAC, IBM, INTC, JPM, WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may trade any of the stocks/ETFs mentioned in this article in the next 72 hours.
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