Is the DOW Overvalued?
Question: Consider four statistics for the 30 stocks in the DOW Jones Industrial average – the PE ratio, the PEG ratio, the dividend yield and the dividend payout ratio. Do these statistics indicate the DOW is overvalued? What leads you to your conclusion?
Note: Many of the statistics are unavailable for Dow-Dupont a company, which resulted from the merger of two chemical giants. As a result, the statistics presented here are based on 29 of the 30 Dow components. The calculations presented here are based on price and financial data available October 1, 2017.
The composite trailing earnings PE ratio of the 29 DOW stocks is 20.5. This is high compared to the normal PE ratio for these stocks.
10 of the 29 DOW stocks have a PE ratio exceeding 25.
The median PEG ratio for the 29 stocks is 1.83. 26 of the 29 PEG ratios are greater than 1.0. PEG ratios higher than 1 suggest the company is overvalued compared to growth opportunities.
The median dividend yield on the 29 stocks is 2.4 a bit higher than the yield on the 10-year Treasury, which finally appears to be rising.
6 of the 29 companies have a payout ratio greater than 100. These firms paid out more in dividends than they earned; hence, they may need to soon cut dividend payouts.
Discussion: David Stockman, the former budget director, predicts that it is likely the stock market could plunge 40 to 70 percent.
The DOW is only 30 stocks (and I am looking at 29) so this post does not speak to the entire market but I am not reassured by the numbers reported here.
The high median PEG ratio is a bright red flag.
The high PE ratio stems not very strong growth prospects or strong earnings but from a dividend yield that exceeds bond yields. Bond yields will rise soon.
The finding that more than 20 percent of the firms in the DOW pay a dividend that is larger than earnings (an unsustainable situation) is troubling and suggests that firms may cut dividends and at the very least will not increase dividend yields to keep up with higher interest rates.
Concluding Thought: Is it typical for 20 percent of established firms in the DOW to pay more in dividends than they earn? It is likely that high dividend payouts are even a more severe problem in three sectors – REITS, utilities, and energy. I will look at sectors next week.
I don’t share much of David Stockman’s world view but I fear that if the market continues to rise for another year or two the magnitude of the coming correction will be closer to Stockman’s upper bound than his lower bound.