Dow Jones Transportation Average Examined By Graham's Criteria

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Includes: ALK, CAR, CHRW, CNW, CSX, DAL, EXPD, FDX, JBHT, JBLU, KEX, KSU, LSTR, LUV, MATX, NSC, R, UAL, UNP, UPS
by: Difu Wu

Summary

Ben Graham's stock selection criteria are tried and true for the defensive investor.

Transportation stocks, represented by the Dow Jones Transportation Average (DJTA), are inappropriate for the defensive investor today.

The enterprising investor may gain speculative profits by timing the boom and bust cycle of the DJTA, but he too would be wise to stay away at current valuations.

Previously, we examined both the Dow Jones Industrial Average (DJIA) and the Dow Jones Utility Average (DJUA) using Benjamin Graham's stock selection criteria, and found both unsavory for the defensive investor at current valuations. Below are Graham's 7 stock selection criteria revisited:

Quality

1. Adequate Size of the Enterprise. Graham suggested at least $100 million of annual sales for an industrial company, and at least $50 million of assets for a public utility. These 1973 figures can be adjusted for inflation to roughly $500 million of annual sales and $250 million of assets today (2014). Market capitalization, used by many as a proxy for size, confuses market valuation with business fundamentals. While the two are very much correlated, they may widely diverge at times, and paying exorbitant price for a small business is the exact opposite of defensive investing.

2. A Sufficiently Strong Financial Condition. Current ratio should be at least 2 to 1 for industrial companies; debt to equity should be no more than 2 to 1 for public utilities.

3. Earnings Stability. Some earnings in each of past ten years.

4. Dividend Record. Uninterrupted payments for at least the past 20 years.

5. Earnings Growth. A minimum of at least one-third in per-share earnings in the past ten years using three year averages at the beginning and the end. Multi-year average earnings smooth out cyclical earning variations and better reflect a company's true earning potential. This corresponds to 2.9% compound annual growth, a relatively low hurdle.

Quantity

6. Moderate Price/Earnings Ratio. Current price should be no more than 15 times average earnings of the past three years. Again, ignore single year earnings. P/E ratios calculated using trailing twelve month earnings or predicted earnings for the next 12 months are unreliable.

7. Moderate Ratio of Price to Assets. Current price should be no more than 1.5 times the book value last reported.

Alternatively, the product of P/E and P/B should not exceed 22.5. A stock meeting this alternative criterion may be considered as fulfilling both quantity criteria and admitted for investment.

Application of Graham's Criteria to the DJTA in 2014

Let us now turn our attention to the 20 prominent issues in the Dow Jones Transportation Average (DJTA), to see how many, if any, meet these stringent criteria for the defensive investor. The DJTA, dating back to 1884, is the oldest index still in use today, even older than the well-known DJIA. Graham was critical of transportation stocks back in 1970. At that time, the railroads had suffered from severe competition. Penn Central Transportation Co., which had a long history of uninterrupted dividends for over 120 years, shocked the financial world by its bankruptcy in 1970. In Graham's words:

There is no compelling reason for the investor to own railroad shares; before he buys any he should make sure that he is getting so much value for his money that it would be unreasonable to look for something else instead.

What can we say about the DJTA today, which includes not only railroads, but also airlines, trucking, delivery services, marine transportation, and car rental services? The table below lists the 20 DJTA stocks with the Graham criteria. These data are obtainable from SEC filings.

Stock

Ticker

Price

Sales

Current ratio

Earnings stability?

Yrs of Uninterrupted Dividends

2002-2004 Avg Earnings

2011-2013 Avg Earnings

Earnings Growth

Price to Earnings

Book value

Price to Book

(P/E)*(P/B)

# Criteria Met

Alaska Air Group

ALK

56.06

5270

1.02

No

2

(0.38)

2.48

NM

22.60

16.70

3.36

75.88

1

Avis Budget Group

CAR

57.30

8450

1.26

No

0

1.29

0.76

-41.09%

75.39

7.08

8.09

610.19

1

CH Robinson Worldwide

CHRW

71.90

13270

1.37

Yes

17

0.65

2.98

358.46%

24.13

6.95

10.35

249.61

3

Con-Way

CNW

46.24

5720

1.55

No

20

0.39

1.42

264.10%

32.56

21.82

2.12

69.01

3

CSX

CSX

35.83

12510

1.20

Yes

33

0.25

1.76

604.00%

20.36

11.17

3.21

65.30

4

Delta Air Lines

DAL

46.25

39790

0.74

No

1

(19.30)

4.83

NM

9.58

14.74

3.14

30.05

2

Expeditors International

EXPD

43.27

6420

2.41

Yes

21

0.59

1.68

184.75%

25.76

9.85

4.39

113.14

5

FedEx

FDX

167.95

46230

1.80

Yes

12

2.61

6.02

130.65%

27.90

53.38

3.15

87.78

3

JB Hunt Transport

JBHT

83.18

6030

0.93

Yes

11

0.61

2.52

313.11%

33.01

9.90

8.40

277.33

3

JetBlue Airways

JBLU

15.15

5740

0.63

No

0

0.50

0.40

-20.00%

37.88

8.18

1.85

70.15

1

Kansas City Southern

KSU

115.53

2550

1.02

Yes

3

0.42

3.20

661.90%

NM

32.98

3.50

NM

3

Kirby

KEX

88.85

2470

1.56

Yes

0

0.80

3.83

378.75%

23.20

39.31

2.26

52.43

3

Landstar System

LSTR

71.33

3020

1.94

Yes

1

0.89

2.77

211.24%

25.75

11.08

6.44

165.78

3

Matson

MATX

33.17

1680

2.27

Yes

2

1.89

1.05

-44.44%

31.59

8.52

3.89

122.99

3

Norfolk Southern

NSC

105.44

11640

1.45

Yes

32

1.51

5.62

272.19%

18.76

40.20

2.62

49.21

4

Ryder System

R

88.76

6600

0.76

Yes

34

2.28

3.97

74.12%

22.36

37.38

2.37

53.09

4

Southwest Airlines

LUV

40.15

18400

0.77

Yes

34

0.41

0.61

48.78%

65.82

10.95

3.67

241.34

4

Union Pacific

UNP

115.06

23460

1.25

Yes

34

1.12

4.07

263.39%

28.27

24.19

4.76

134.47

4

United Continental Hldg

UAL

63.11

38920

0.72

No

0

(4.00)

0.54

NM

116.87

10.45

6.04

705.81

1

United Parcel Service

UPS

108.55

57310

1.46

Yes

15

2.76

3.09

11.96%

35.13

6.19

17.54

616.04

2

DJTA

   

15774

1.31

Yes

14

   

215.99%

35.63

 

5.06

199.45

3

Graham's admonitions remain relevant today as ever. Only one issue (Expeditors International) met all 5 quality criteria, and many failed multiple quality criteria. All 20 issues failed the quantity criteria. Not only is there no compelling value to be found here, there is compelling reason to look elsewhere, as the DJTA compares poorly against both the DJIA and the DJUA, shown below.

Number (percent) of issues meeting Graham's criteria

Graham's Criteria

DJIA

DJUA

DJTA

Size

30/30 (100%)

15/15 (100%)

20/20 (100%)

Financial Condition

7/30 (23%)

13/15 (87%)

2/20 (10%)

Earnings stability

29/30 (97%)

11/15 (73%)

14/20 (70%)

Dividend record

26/30 (87%)

10/15 (67%)

7/20 (35%)

Earnings growth

24/30 (80%)

6/15 (40%)

13/20 (65%)

Moderate price to earnings

6/30 (20%)

2/15 (13%)

1/20 (5%)

Moderate price to assets

4/30 (13%)

4/15 (27%)

0/20 (0%)

All the issues in each index met the low hurdle for size. The DJTA scored worse on every one of the other six criteria compared to the DJIA, and worse than the DJUA on every criterion except earnings growth.

Salient Aspects of the DJTA Today

1. Size is adequate, with all twenty issues easily surpassing the minimum $500 million of annual sales stipulated.

2. Financial condition is unsatisfactory, both in the aggregate, as well as in 18 out of 20 issues failing to have a current ratio at least 2 to 1.

3. Earning stability is satisfactory in the aggregate, but 6 out of these 20 issues failed this criteria, a worse showing compared to both the DJIA and DJUA. The railroads actually have the best record here, a significant shift from 1970. Now, the airlines are the ones with the poorest records with multiple years of earnings deficits.

4. Dividend record is poor, with an average of only 14 years for the DJTA, which is woefully inadequate compared to an average of 67 years for the DJIA. Only 7 out of these 20 issues passed with at least 20 years of interrupted dividends.

5. Earnings growth is satisfactory in the aggregate, but with great variations among the components, 7 out of 20 failing this criterion.

6. Ratio of price to three-year average earnings was 35.6 for the DJTA today, which is 137% greater than the maximum 15 required. The DJTA today is significantly more amply valued compared to both the DJIA and the DJUA, which have ratio of price to three-year average earnings of 20.5 and 26.6, respectively.

7. Ratio of price to net asset value was 5.06 for the DJTA today, which is 227% greater than the maximum 1.5 required. This is significantly more expensive compared to a ratio of 4.40 for the DJIA and 1.94 for the DJUA.

Conclusion

Graham's judgment on the DJTA in 1970 resonates today, proving the dictum "plus ça change, plus c'est la même". The DJTA remains shockingly poor in quality and extremely highly priced relative to earnings and assets. The only difference for the DJTA between 1970 and 2014 is that after a period of consolidation, the few railroad stocks that remain, such as Union Pacific, CSX, and Norfolk Southern, have gained a competitive advantage and are now among the highest quality of the 20 DJTA issues, while the competitive environment remain challenging for the other modes of transportation, especially the airlines with their infamous history of bankruptcies. The DJTA is prone to volatile cycles of boom and bust. While a defensive investor should stay away from the DJTA, an enterprising investor may obtain spectacular returns by timing the market cycle right, such as buying on March 9, 2009, when the index closed at 2146.89, yielding over 300% return to date. At current valuations, however, we may say that the investor is getting so little value for his money that it would be unreasonable not to look for something else instead. To buy the DJTA issues today is to court disaster.

Disclosure: The author is long CSX, NSC.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.