Dow Has Room To Run -- If Profits Meet Estimates


The Dow Theory is premised on the idea that averaging the share prices of the 30 stocks in the Dow Jones Industrial Average reveals more about the market's trend than looking at each of the 30 stocks individually. By aggregating the 30 stocks into a single index, company-specific moves tend to even out, meaning swings in the index tend to reflect broad shifts in investors' outlook.

Still, nothing says trend analysis must be used to the exclusion of all other considerations, and one advantage of the Dow is its relatively small number of stocks. With just 30 members, the Dow lends itself to analyses based on the characteristics of its individual components.

On average, the 30 companies in the Dow Industrials are expected to deliver per-share- earnings growth of 10% to 11% both this year and next. The 20 Dow Transports are expected to average 27% growth this year, followed by 16% growth next year. The Transports trade at considerably higher average trailing P/E ratios, though both sets of stocks trade within 10% of five- and 10-year norms.
For 30
For 20
Expected curr.-yr. EPS growth (%)
Expected next-yr. EPS growth (%)
Trailing P/E
Expected current-year P/E
Expected next-year P/E
Median trailing P/E last 5 years
Median trailing P/E last 10 years

With that in mind, we calculated target prices for each of the 30 stocks based on each stock's five- and 10-year norms for trailing price/earnings ratio. We did the same for the 20 stocks in the Dow Transports, aiming to gauge the market's upside potential. Among our conclusions:

• Price targets based on trailing earnings suggest the Industrials and Transports are fairly valued relative to historical norms. If every stock in the Industrials moved to its 10-year median P/E ratio today, the Dow would trade at 16,056, up about 11%. The Transports would trade at 6,423, up about 3%. Based on five-year median P/Es, both indexes would be slightly lower.

• Price targets based on consensus estimates for current-year earnings point to solid upside — assuming stocks move to their 10-year median P/Es. If all 30 Dow Industrial members exactly meet their current-year profit estimates — and all 30 stocks move to P/Es in line with 10-year norms — the average would trade at 16,974 in early 2014. A return to 10-year median P/Es does not seem like a huge stretch, as the last decade included both booms and busts. But current-year profit estimates tend to be unduly optimistic at this time of year.

• Based on next-year profit estimates, both averages have decent upside, even if P/E ratios dip to the five-year norms. Interestingly, even after gaining nearly 30% since mid-November, the Dow Transports have more upside than the Dow Industrials based on next-year profit estimates. Of course, consensus estimates for the Transports project 27% average profit growth this year and 16% next year, versus 10% to 11% in both years for the Industrials.

• Among the Industrials, buy-rated stocks with considerable upside potential include American Express ($65; AXP), Cisco Systems ($22; CSCO), and J.P. Morgan Chase ($49; JPM). Based on an average of the six target prices we calculated, all three stocks have at least 25% upside potential.

• None of the Dow Transports are on our Buy List, though A-rated Union Pacific ($140; UNP) has solid upside potential based on our target prices. Small-cap Ryder Systems ($60; R), recommended in our sister publication Upside, has 25% upside based on an average of our six target prices.


The Industrials and Transports have considerable upside potential — assuming consensus profit estimates are reasonable and P/E ratios don't contract sharply. With the Dow Jones Industrial Average trading at a trailing P/E of 16 — only slightly above its 100-year norm of 14 to 15 — we are more worried about disappointing profits than excessive valuations.

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