Monday, October 2, 2017

Is the DOW Overvalued?

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.

Results:


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.


Wednesday, August 9, 2017

Evaluation of an Energy ETF

A Discussion of Vanguard’s Energy ETFs in Early August 2017

Question:   What are the PE ratios for the ten largest positions in VDE?  What is the aggregate PE ratio for these ten stocks?

Comment on the valuation of the energy sector in early August 2017.


PE ratios for Ten Largest Holdings of VDE
Company
P/E
Exxon Mobil Corp
33.36
Chevron Corp
71.6
Schlumberger Ltd
-47.3
ConocoPhillips
-36.2
EOG Resources Inc
-85.6
Occidental Petroleum Corp
-87.27
Phillips 66
26.38
Kinder Morgan Inc P
65.4
Halliburton Co
-10.46
Valero Energy Corp
14.82


Comments on these PE ratios:

  • Five of the ten firms have negative earnings and no defined PE ratio.


  • Only two firms Valero energy and Phillips 68 have a PE ratio under 30.


The calculation of the aggregate PE ratio for the ten largest holding of VDE:

The most straight forward way to calculate the PE ratio of a group of firms when some firms have negative earnings involves dividing the sum of the market values of the firms by the sum of the earnings of the firms.   This calculation is presented below.
  

Company
Market Cap
Earnings
Exxon Mobil Corp
338.8
10.2
Chevron Corp
209.1
2.9
Schlumberger Ltd
91.0
-1.9
ConocoPhillips
55.5
-1.5
EOG Resources Inc
52.6
-0.6
Occidental Petroleum Corp
46.9
-0.5
Phillips 66
43.5
1.6
Kinder Morgan Inc P
44.1
0.7
Halliburton Co
35.8
-3.4
Valero Energy Corp
30.3
2.0
PE Ratio
Total
947.7
9.4
100.4


The aggregate PE ratio for the ten holdings is 100.4.

An alternative algebraic procedure can be used to obtain the PE ratio of a group of firms when some firms have negative earnings.

Go here for a discussion of this other method.

Comment on PE ratio reported here and PE ratios reported by CNBC:

On August 9, 2017 CNBC reported that VDE has a PE ratio of 3.23.   They appear to be taking a weighted average of the PE ratio for all stocks. THIS IS WRONG!  

PE ratios of firms with negative earnings are totally meaningless.   Look at Occidental Petroleum.  Its PE ratio of -87 would be even a larger negative number if it earnings increased slightly towards zero. 

An examination of the PE ratios of the holdings of VDE indicates that VDE is overvalued.   The PE ratio reported by CNBC is highly misleading.

Concluding Remark:   Oil prices at least as measured in dollars have rebounded from their trough.   However, earnings have not rebounded and PE ratios are high.   Why are energy stock valued so high compared to the earnings these firms are generating?   

Potential Reasons:

  • Interest rates are low and safe assets are earning very little.


  • Some oil stocks may be viewed as a safer bet than some tech stocks.


  • Financial analysts are not providing accurate information on the valuation of this sector and other sectors.


  • Investors may believe that an increase in oil prices will soon increase earnings.

  • Investors are betting that the FED will keep its expansionary monetary policy forever


The gist of this post is that the major players in the energy sector are not in good shape. Smaller firms in the ETF may be even worse off.   Investors appear to be flocking to ETFs without conducting a detailed examination of the holdings of the ETF.    I believe there is a market for software that will automatically provide a detailed evaluation of ETF holdings and risk.   More on this topic to follow.