In the Monday's Wall Street Journal they revisited the work of our analytical opponents, James Glassman and Kevin Hassett, of "Dow 36,000" fame. The authors have no ill feelings regarding their astronomic forecast. In fact, they still stand by their Dow 36,000 prediction, but they are "just not going to give a date." Recall, they based their prognostication on the theory that stocks are less risky than bonds. This premise is based solely on the fact that stocks have enjoyed better average returns historically. There is no regard to the fact that equity shareholders are the last in line should a company declare bankruptcy. Unfortunately, this has not been lost on numerous shareholders this year. The article contained some criticism. Most notably from economist Paul Krugman: "…they may have had one digit too many in their title, lets hope it was an extra 3, not an extra 0." Inspired by this question, and the chance to write a new book called Dow 3600, we did a simple "back of the envelope" valuation of the Dow Jones Industrial Average.
Armed with only a Value Line, a calculator, and some common sense, I set off to value the 30 stocks that comprise the DJIA. Sorry, no fancy dividend discount models that use earnings from the year 2118 to calculate value, just the P/E's and earnings power estimates that portfolio managers use in the real world.
In the majority of cases, I used the 2002 Value Line earnings estimate, but in the case of companies with cyclical earnings I used an estimate of mid-cycle earnings. These earnings were then valued using a P/E multiple that was a generous estimate of their true long-term earning growth potential. The multiple ranged from 15x for the fastest growers, to 6x for one company with little growth potential. For some stocks that had highly volatile earnings, I used estimates of 2002 book value, and applied a reasonable multiple of book value that the stock had traded for in the past. Obviously there is quite a bit of judgment involved, but if you wish to supplement your own opinions the table below can be adjusted to suit your own tastes
Using the first set of estimates, I calculated a "fair value" of the DJIA of 4,216. But as we have all learned, stocks will often sell well below and well above fair value. Additionally, the P/E estimates used in my table could well be too high and the earnings estimates could also be far too optimistic as the double-dip recession sets in. This "fair value" that I calculated of the DJIA is twelve percent of the 36,000 target Glassman and Hassett forecasts. If this was Japan twelve years ago, Glassman and Hassett would likely be forecasting a Nikkei of 100,000, instead of seeing the asset bubble that was about to pop.
Since I am a betting man, I'd say we have a better chance of 3,600 before we see 36,000. Care to wager a few Gold Eagles Mr. Glassman and Mr. Hassett?
The opinions expressed below are those of the author, and do not necessarily represent those of station management. The DJIA is simply calculated by adding together the 30 stock prices and dividing by the divisor which according to Bloomberg is now .1444 ( it was originally 30 when the index was created).
|Company||Ticker||Price to Book||Book Value||Implied Price||Current Price|
|Intl Paper Co||IP||1||24.05||24.05||$39.82|
|General Motors Corp||GM||0.5||44.65||22.33||$46.55|
|J P Morgan Chase & Co||JPM||0.5||10.63||5.32||$24.96|
|Sum of Prices using Book Value||$146.17||$326.90|
|Company||Ticker||Price to Earnings||EPS Estimate||Implied Price||Current Price|
|Johnson & Johnson||JNJ||15||2.20||33.00||$53.00|
|Home Depot Inc||HD||12||1.20||14.40||$30.88|
|Procter & Gamble Co||PG||12||3.45||41.40||$88.99|
|General Electric Co||GE||12||1.65||19.80||$32.20|
|Merck & Co||MRK||12||3.13||37.56||$49.60|
|Disney (Walt) Co||DIS||12||0.75||9.00||$17.73|
|Exxon Mobil Corp||XOM||9||2.00||18.00||$36.76|
|SBC Communications Inc||SBC||9||2.45||22.05||$27.66|
|United Technologies Corp||UTX||9||3.00||27.00||$69.50|
|Du Pont (E I) De Nemours||DD||9||2.00||18.00||$41.91|
|Honeywell International Inc||HON||9||2.35||21.15||$32.36|
|Intl Business Machines Corp||IBM||9||3.00||27.00||$70.40|
|Eastman Kodak Co||EK||6||2.15||12.90||$30.78|
|Sum of Prices using Earnings||$462.57||$935.12|
|Sum of All Prices||$608.74||$1,262.02|
|Price of Dow Jones Industrial Average||4,215.62||8,739.75|
(Alphabetical by company name)
- Alcoa (A) - The stock sold for 1 times book in 1991.
- American Express (AXP) - Their credit card asset problems will not be as bad as some, but 1 times book value is still appropriate for financial companies when asset quality comes into question.
- AT&T (T) - The balance sheet is so ugly, even half of book value may be generous.
- Boeing (BA) - Earnings have been historically cyclical, so I used $2.00 as an estimate of mid-cycle EPS.
- Caterpillar (CAT) - The stock sold at one times book in 1991.
- Citigroup (C) - The stock sold at half of book in 1991, and I didn't factor in any likely writdowns.
- Coca Cola (KO) - With earnings nearly flat for the last 4 years, a multiple of 12 times earnings is quite generous.
- Disney (DIS) - Earnings have been bouncy, so I used $.80. Due to recent growth trends, 12 times earnings could be too generous.
- Du Pont (DD) - earnings have been erratic; the 2002 guestimate seems like a mid-point.
- Eastman Kodak (EK) - This was the only company I used a 6x multiple because earnings prospects are so poor.
- Exxon Mobile (XON) - Earnings have been erratic, again the 2002 guestimate looks like a mid-point.
- General Electric (GE) - A 12 times multiple is very generous given that about half of earnings come from the financial business whose asset quality will soon be in question.
- General Motors (GM) - The stock sold at half of book value in 1991.
- Hewlett-Packard (HPQ) - If Dell is successful in printers, the $.80 earnings power would be in question.
- Home Depot (HD) - I just can't bring myself to use the $1.50 estimate here. We learned the past few years that tech earnings are cyclical. We will soon learn home building and home improvement are also more cyclical than many realize. Consequently, I am using $1.20 as a guess of mid-point earnings for the cycle.
- Honeywell (HON) - Yawn, earnings have been flat for 4 years.
- IBM (IBM)- Who knows what real earnings power is given the goulash that this company calls its reported earnings. There are so many charges and unusual items that we gave the reported number a 25% haircut and called earnings power $3.00 even though we suspect it is less.
- International Paper (IP) - The stock traded below book value in 1990.
- Intel (INTC) - Proving to be just as cyclical as the old US Steel, Intel deserves a valuation of two times book value. Incidentally, this is where the stock traded in 1991.
- Johnson & Johnson (JNJ) - Recent problems could put the 15% growth rate in question
- JP Morgan Chase (JPM) - If auditors cannot tell the difference between an operating expense and a capital expenditure, how in the $#!&!@ can they value a $24 trillion dollar derivative position. I cut stated book in half, and then assumed the stock would sell at half that estimate. Quite frankly $5/share is my best case estimate of JPM's true value.
- McDonalds (MCD) - Growth has slowed to crawl, so 12 times earnings is generous.
- Merck (MRK) - Growth has been less than 10% the last two years, so 12 times earnings is reasonable.
- Microsoft (MSFT) - I could not use stated earnings in good conscience without taking some discount for un-expensed options, so I cut the earnings estimate from $1.80 to $1.50.
- Philip Morris (MO) - This is by far the most difficult valuation estimate because of the overhanging legal issues. I'll guess that the yield can get back 8% at the point of maximum pessimism. That equates to a stock price of $29, or about 3 times book value.
- Procter & Gamble (PG) - This company will be hard pressed to grow at 12%, but it is possible.
- SBC Communications (SBC) - Recent earnings growth has been in the low single digits.
- 3M (MMM) - Earnings have fluctuated, so I used $4.00 as an estimate of earnings power.
- United Technologies (UTX) - Earnings are cyclical, so I used a $3.00 estimate of the mid-point.
- Wal Mart (WMT) - If earnings continue to grow at 15% much longer, they will be the only retailer on the planet.