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Dissecting the Dow: 21 of the 30 Dow Stocks are Undervalued, 6 are Fairly Valued, and Only 3 Appear Overvalued


In this final segment, we will cover the 10 poorest performing DJIA stocks since 1995. In part one which covered the best 10 performing DJIA stocks; we saw a group of companies that could best be described as consistent above-average earnings generators. Consequently, it makes sense that they were the best performers since we chose calendar year 1995 as our starting point which was a time when most stocks were fairly valued. In other words, we neutralized valuation, which is one of the key determinates of long-term return.

In part two we discovered a mixture of consistent growers with many that were cyclical in nature. Therefore, as more cyclical companies entered the fray, the worse the long-term performance that they generated for shareholders became. Since valuation was pretty much a constant, for both consistent growth and cyclical companies, the thesis that earnings determine long-term performance is validated. Ceteris paribas, better earnings results produced better performance.

In this final part three of our series you will discover that a predominant number of very cyclical and slow growing companies encompass this universe. Therefore, it is not surprising that these are the 10 worst performers of the DJIA stocks. By examining each of the 30 DJIA stocks individually, the reader can begin to understand the relevance of our thesis stating that it is a market of stocks, not a stock market.

The primary reason behind the exercise of dissecting each of the 30 DJIA stocks one at a time, was to illuminate why we believe investors should focus more on their specific holdings, in lieu of concerning themselves with the general or overall market. Regardless of what the market may or may not be doing in the short run, in the long run actual performance is functionally related to the performance of the individual business assuming that beginning valuation is rational. In this case there is causation behind the correlation of earnings and price.

Interpreting the Earnings and Price Correlated F.A.S.T. Graphs™

The ability to look deeper into specific stock valuations beyond a mere market average is one of many reasons that motivated us to develop our F.A.S.T Graphs™ (Fundamentals Analyzer Software Tool™). We wanted specific research, rather than relying on often miss-leading statistical references. Our F.A.S.T. Graphs™ allow us to evaluate the specific sources of long-term investor returns on over 17,000 symbols.

We use three formulas for determining valuation: For companies growing earnings at 15% or better, the graphs utilize a PEG ratio (PE equal to Earnings Growth Rate) calculation for value (marked PEG in orange ink). For companies growing earnings at 5% or less, the graphs use Ben Graham's formula for value. These graphs are (marked GDF in orange ink) followed by the number that represents the value PE ratio. For companies growing earnings between 5% and 15%, the graphs use a modified version of the first two (marked in orange ink GDF-EDMP) then again followed by the number representing the calculated value PE ratio.

Therefore, the orange line with white triangles represents fair value for each respective company. In other words, when the black price line touches the orange earnings justified valuation line, the stock is theoretically in value. Prices above the orange fair value line indicate overvaluation and prices below the orange fair value line indicate undervaluation.

Keep in mind that fair value does not necessarily imply high or good returns. Slow earnings growers, even when bought in value will, all other things being equal, generate lower returns than faster growing companies bought in value. However, and most importantly, notice how price and earnings correlate on each graph over time (i.e. the trend line movement of price follows earnings).

A Snapshot Summary of Valuation

The following table lists the third or worst 10 best performing Dow stocks in order of highest to lowest performance since calendar year 1995. For each company the table shows the annualized total return, dividend yield, current price earnings ratio, and for a first perspective on valuation, the normal PE ratio that the market has historically applied to the company.

For a second perspective on valuation the table is color-coded by each company's current valuation. When a stock is considered fairly valued, it means that its price is at or near its orange earnings justified value line, and therefore it's colored orange. When a stock is considered undervalued, it means that its price sits below the orange earnings justified value line thereby falling into the green shaded earnings area, and therefore it's colored green. If the stock price is above the orange earnings justified value line, it's considered overvalued and color-coded red implying danger.

Therefore, from the table below it can be gleaned that there are three companies in this universe that are fairly valued, six that are undervalued, and only one that appears overvalued.

Therefore, the score after reviewing all of the 30 DJIA stocks adds up as follows: 21 of 30 are undervalued, 6 of 30 are fairly valued and only 3 appeared overvalued. Of the three that appear overvalued, McDonald's Corp. (MCD) see article one here, and Coca-Cola (KO) see article two here, both are only modestly so based on fundamentals, and the third, Verizon (VZ) is overvalued primarily due to recent drops in earnings (see below).

Stock Analysis

A Pictorial View of Valuation: The 10 Worst Performing Dow Stocks Since 1995

In this part three of this series we will refrain from commenting extensively on each individual company in favor of providing an overview of what we suggest the reader focuses on as they review each individual graph. However, a very brief definition of the operating characteristics of each company will be stated.

To the very right of each graph printed in green ink the reader will find each company's respective earnings growth rate achievement listed. The reader should take into consideration the impact that earnings growth has had on shareholder returns when examining the performance results associated with each earnings and price correlated historical graph.

But perhaps most importantly, notice how stock prices move in tandem with earnings. When earnings rise, the long-term stock price trend line will follow. Conversely, when earnings fall, stock prices will follow. Furthermore, take special notice of how stock prices can temporarily become significantly disconnected from the orange earnings justified valuation line, but also how they inevitably return to fundamental value. The real advantage offered is the ability to see extreme disconnects from valuation, over or under, when it is occurring.

The fact that markets can and will often misprice stocks is undeniable. Furthermore, we have always felt that it is an exercise in futility to attempt to quantify why a market is behaving the way it is when it is behaving irrationally. In other words, irrational behavior is unquantifiable, and therefore, precisely what it is - irrational. Rather than try to explain it, we believe it's more important to recognize it and behave accordingly.

Merck & Co (MRK)

Strong and consistent earnings growth, followed by flat and moderately cyclical earnings growth.

Merck & Co.

Merck & Co

Du Pont (E I) De Nemours (DD)

Very inconsistent and cyclical earnings growth.

Du Pont

Du Pont

Hewlett-Packard Co. (HPQ)

Spurts of earnings growth followed by bouts of cyclicality.



Verizon Communications Inc (VZ)

Five years of moderately fast earnings growth, followed by very slow and even falling earnings.



AT&T Inc (T)

Inconsistent earnings results.

AT&T Inc.

AT&T Inc.

Disney (WALT) Co (DIS)

Cyclical and inconsistent earnings history.



Bank of America Corp (BAC)

Moderate and consistent earnings growth, followed by a collapse after the financial bubble burst.

Bank of America

Bank of America

Alcoa Inc (AA)

Very cyclical and unpredictable earnings performance.

Alcoa Inc

Alcoa Inc

Kraft Foods Inc (KFT)

Spun-off in 2001, therefore a short history. After an initial rise in earnings post spin-off, earnings growth has been very flat.

Kraft Foods Inc.

Kraft Foods Inc.

Travelers Cos Inc (TRV)

A short history post spin-off, with very cyclical earnings performance creating a poor annual price earnings correlation.

Travelers Cos Inc

Travelers Cos Inc


This has been the fourth article in a series dealing with the relative valuations of the so-called "stock markets", where the first looked at the S&P 500, and the last three covered the 30 Dow Jones Industrial Average. The principle idea behind this series is not that the markets are currently fairly valued to even undervalued based on historical precedent. Instead, we are discussing the valuation of the markets based on the intrinsic values of the underlying companies that make up the markets. In short, based on fundamentals, we believe that many quality companies are on sale today.

With this article we have taken a look at each of the individual constituents of the DJIA 30. Clearly, there are many differences in the fundamental results between each of these individual businesses. Furthermore, each company possesses characteristics that are significantly different from each other and from one industry to another industry. On the other hand, it is a fact that stocks will tend to rise and fall in tandem with the general market on any given day, week, month or even year. In other words, stocks tend to move together in the short run.

However, this study has also illustrated that over the longer run there are significant differences in performances between one company to the other, and from any one company compared to the market in general. As long as valuation is reasonably aligned with fundamental value in the beginning, comparisons are primarily driven by the rate of change of earnings growth achieved, and how consistently they were achieved.

Finally, we ask the readers to focus on how quickly an opinion and perspective of any individual company can be made by reviewing the long-term relationship between earnings and price. Literally, in an instant, the investor can determine what kind of company they are looking at and whether or not it is capable of meeting their specific investment objectives and risk tolerances. We believe a specific insight on individual companies is more beneficial and productive than a more general view.


Disclosure: Long HPQ, KFT, TRV & MCD at the time of writing.


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