Is the DJIA Index Ready for Another Double Digit Return?

Feb. 4.11 | About: SPDR Dow (DIA)

The other day, Seeking Alpha was kind enough to allow me to place a banner on the sidebar to the left of my articles and thus allow anyone who wanted the chance to get a free copy of my “Sixty Year Backtest of the DJIA Index from 1950-2009”, showing the power of price to free cash flow in the investment process.

I was pleased with the response, as I have had over a hundred people download my research paper in the last 24 hours.

On top of that, I had some interesting emails from SA readers who reviewed my work, as they were very impressed with the results of the backtest. Here is a brief summary of the results of my backtest:

Specifically, in terms of relative performance, my free cash flow picks beat the DJIA in fifty-five of sixty years tested. Moreover, the average gain for the FCF Portfolio was +21.08% per year over sixty years, compared to an average gain of the DJIA Portfolio of just +6.77%, over sixty years.

But then out of the blue, I got an email from a gentleman named Jack who discovered something very interesting in the data. What he discovered was that anytime there were more than 10 stocks in the DJIA Index that had a price to free cash flow of 15 or less in a given year that the DJIA had a double digit return in each of the 12 years that this phenomenon occurred. There was no other correlation for the rest of the years when there were less than 10 stocks in the DJIA that had a price to free cash flow of 15 or less.

Here is a table showing you what your fellow Seeking Alpha reader discovered:

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When you think about all this, it sounds quite logical, because if more than 1/3 of the index is undervalued in any given year then there is a great probability that the entire index will go up.

Another amazing thing is that if you add up all those years in the table above, you get an average return of 22.13%. Now, if you look at the average return of the entire 60 year backtest, you will see that I got an average return of 21.08%. So it’s kind of spooky for the results to come in so close.

Here is a table for all the years under analysis:

click to enlarge

Click to enlarge

As you will notice in 2011, I analyzed the DJIA Average and came up with 15 stocks that were selling for a Price to Free Cash Flow (P/FCF) of 15 or less. So does this mean that we should have a double digit return for the DJIA as well this year?

I welcome you amateur/pro statisticians out there to analyze the results and see what the probability is that 12 out of 12 would ring true out of 62 years under analysis.

Since this was discovered through the use of Seeking Alpha, I have decided to name it the “Seeking Alpha Effect”. Please take what Jack has discovered and see what you think of the “Seeking Alpha Effect”.

Thank you Jack, and thank you SA for helping me to advance my research and as Jack asked me, should I cover my shorts and go (NYSEARCA:DIA), (NYSEARCA:SPY) and (QQQQ)? As to that, I have no opinion on that matter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.