Dow: An Undervalued 5-Star Market

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 |  Includes: AIG, AXP, BAC, C, DIA, DIS, GE, HD, JNJ, MMM, MRK, PFE
by: Donald Johnson

The 30 stocks in the Dow Jones Industrials are trading for 82% of Morningstar.com's estimated fair value, which makes the Dow an undervalued 5-star market. Eleven of the 30 industrials are undervalued 5-star stocks, according to Morningstar.

Those 5-star stocks are depressed. They are depressed because the market doesn't like their recent earnings reports nor their apparent prospects for the next year or more. Morningstar's fair value estimates are based on discounted cash flow calculations and the opinions of Morningstar's securities analysts who follow the individual stocks closely. In other words, the Morningstar stock pickers think these companies will turn around and appreciate over the next 12 to 24 months.

By their nature, then, five star markets and five star stocks are risky. That's why they're trading below Morningstar's estimates of their fair values. The question then becomes, at what point does a trader decide that the Dow or the Morningstar 5-star stocks are as cheap as they're likely to get before they start going up again? When will the market decide that the fundamentals for any of these stocks or the Dow are turning around and that they are worth speculating on for swing trades or for the long term?

Clearly, a five-star rating means that the market is more pessimistic than optimistic about the Dow and the 5-star stocks at the moment. The Dow and the 5-star stocks are on sale, and their technicals suggest that the sale could get better before they bottom out. Daily charts for the exchange traded funds that track the Dow (NYSEARCA:DIA), Nasdaq (QQQQ) and Standard & Poor's 500 (NYSEARCA:SPY) are here. Their point and figure charts are here. All three indexes' point and figure charts show bullish price objectives. But if the market continues to correct, those price objectives will at some point turn bearish.

The 11 undervalued 5-star stocks that are in the Dow include: 3M Company (NYSE:MMM), which closed at 78% of fair value. American Express (NYSE:AXP), 65%. American International Group (NYSE:AIG), 49%. Bank of America (NYSE:BAC), 61%. Citigroup (NYSE:C), 62%. General Electric (NYSE:GE), 72%. Home Depot (NYSE:HD), 64%. Johnson & Johnson (NYSE:JNJ), 81%. Merck (NYSE:MRK), 77%. PFE (NYSE:PFE), 63%. Walt Disney Company (NYSE:DIS), 83%.

Daily charts for these stocks are here and here. Click on a chart to see weekly and point and figure charts. Point and figure charts for these stocks are here and here.

AXP, C, DIS and JNJ point and figure charts have bullish price objectives, which are not predictions. Morningstar is a highly regarded independent stock market research firm and employs very qualified stock pickers.

But not all independent stock research firms or securities analysts who work for brokerage firms agree with Morningstar's fair value estimates. So don't take its estimates as a consensus of analysts' fair value estimates or as the final word about the value of individual stocks or of the Dow Jones Industrials.

The point of this exercise is to look at individual stocks in the Dow and to get a feel for its weakest and strongest components and how they are likely to perform over the long term. Bottom fishers and Warren Buffett-style investors will consider buying some of these 5-star stocks, which obviously are market laggards. Momentum players focus on market leaders and won't give the 5-star stocks a second glance.

Full disclosure: I don't own any of these stocks.