Dow: An Undervalued 5-Star Market

by: Donald Johnson May 27, 2008 | about stocks: AIG / AXP / BAC / C / DIA / DIS / GE / HD / JNJ / MMM / MRK / PFE    

Donald Johnson

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The 30 stocks in the Dow Jones Industrials are trading for 82% of Morningstar.com's estimated fair value, which makes the Dow an undervalued 5-star market. Eleven of the 30 industrials are undervalued 5-star stocks, according to Morningstar.

Those 5-star stocks are depressed. They are depressed because the market doesn't like their recent earnings reports nor their apparent prospects for the next year or more. Morningstar's fair value estimates are based on discounted cash flow calculations and the opinions of Morningstar's securities analysts who follow the individual stocks closely. In other words, the Morningstar stock pickers think these companies will turn around and appreciate over the next 12 to 24 months.

By their nature, then, five star markets and five star stocks are risky. That's why they're trading below Morningstar's estimates of their fair values. The question then becomes, at what point does a trader decide that the Dow or the Morningstar 5-star stocks are as cheap as they're likely to get before they start going up again? When will the market decide that the fundamentals for any of these stocks or the Dow are turning around and that they are worth speculating on for swing trades or for the long term?

Clearly, a five-star rating means that the market is more pessimistic than optimistic about the Dow and the 5-star stocks at the moment. The Dow and the 5-star stocks are on sale, and their technicals suggest that the sale could get better before they bottom out. Daily charts for the exchange traded funds that track the Dow (DIA), Nasdaq (QQQQ) and Standard & Poor's 500 (SPY) are here. Their point and figure charts are here. All three indexes' point and figure charts show bullish price objectives. But if the market continues to correct, those price objectives will at some point turn bearish.

The 11 undervalued 5-star stocks that are in the Dow include: 3M Company (MMM), which closed at 78% of fair value. American Express (AXP), 65%. American International Group (AIG), 49%. Bank of America (BAC), 61%. Citigroup (C), 62%. General Electric (GE), 72%. Home Depot (HD), 64%. Johnson & Johnson (JNJ), 81%. Merck (MRK), 77%. PFE (PFE), 63%. Walt Disney Company (DIS), 83%.

Daily charts for these stocks are here and here. Click on a chart to see weekly and point and figure charts. Point and figure charts for these stocks are here and here.

AXP, C, DIS and JNJ point and figure charts have bullish price objectives, which are not predictions. Morningstar is a highly regarded independent stock market research firm and employs very qualified stock pickers.

But not all independent stock research firms or securities analysts who work for brokerage firms agree with Morningstar's fair value estimates. So don't take its estimates as a consensus of analysts' fair value estimates or as the final word about the value of individual stocks or of the Dow Jones Industrials.

The point of this exercise is to look at individual stocks in the Dow and to get a feel for its weakest and strongest components and how they are likely to perform over the long term. Bottom fishers and Warren Buffett-style investors will consider buying some of these 5-star stocks, which obviously are market laggards. Momentum players focus on market leaders and won't give the 5-star stocks a second glance.

Full disclosure: I don't own any of these stocks.

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This article has 9 comments:

  •  
    May 27 09:06 AM
    Nice piece
    Reply | Link to Comment
  •  
    May 27 10:26 AM
    If you are playing for a bear market bounce, you missed it. Otherwise, the rebound in these stocks could be at least 12-18 months away. The consumer is either out of money, broke or weakening and this will do little for banks and insurance companies. Big Pharma is a crapshoot at this point and GE is basically a finance company.
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  •  
    May 27 01:00 PM
    Thank you for the advice for PFE.We proceeded already with 4.000 shares.We have been waiting for months.Thank you.
    Reply | Link to Comment
  •  
    May 27 07:19 PM
    Pfizer hit another low today. I have an order in for $16.50--let's see if it executes! I made a smaller purchase today.

    I think Citigroup is another interesting company--I am currently running through its financials. There is a chance that C will reduce its dividend. My sense is that PFE won't risk tinkering with its dividend.
    Reply | Link to Comment
  •  
    May 28 12:01 AM
    Yup, you're nuts if you're not buying BAC and C right now. Who cares what they're selling for when they're paying 6% and 7% dividends with a pole position for an economic recovery?

    Where do you think people are going to go for money when the "recession" panic clears -- WalMart? Yeesh!
    Reply | Link to Comment
  •  
    May 28 12:17 PM
    It's tough to argue with Mr. Johnson's assessment of these major players; most of them are in my portfolio and I am very willing for him to be right! However, AIG (my second largest holding) is problematic. This company is like an out-of-control freight train heading for almost certain disaster. Sullivan is so far over his head it is shameful. It's hard to believe but a good $80 billion has been vaporized to date and I don't see who/ what is going to step in to effect a change in course.

    Your over-all take on the major players you mention is probably correct with this one exception.....it almost makes me gag to have to look at the reality of AIG; right now it is OVER-VALUED!!!
    Reply | Link to Comment
  •  
    May 30 04:33 PM
    There's certainly a lot of value in this market right now, but the trick is finding value that doesn't Bear Sterns on you, or sit there doing nothing for the next 12-18 months before things come off the bottom. GE is far more diversified than any of the others and is making strong efforts at conserving and generating cash. The dividend at over 4% is plenty to keep me in for the long haul, even if it sits on the bottom for a year or two. I continue to buy in as the price goes down (I've thought it's been a bargain since $32.5).

    While I hold PFE, I also have my concerns for long term growth with their biggest moneymaker, Lipitor, coming off patent in 2010. It think the dividend is safe until then, but at that point, all bets are off. That may hold the current price where it is until then.

    As for financials, I'm looking at companies that have been smarter than the average bear and managed to avoid the mass of sub-primes like JP Morgan Chase. They're one of the only one's healthy enough to sustain their dividends and continue to pick up bargain acquisitions along the way. Still, I predict stock prices in the financial sector will be flat at best, with a likely downward trend for the next 6-12 months as we figure out just how slow this economy can go without stalling.
    Reply | Link to Comment
  •  
    Jun 05 12:15 PM
    Shareholders need to quit following company recommendations when they sign those proxies. It is time to revolt against the revolting officers who are running these once-great companies into the ground. They're getting their huge salaries and bonuses and stock options while screwing over the shareholders.

    Pfizer's dividend IS in jeopardy because it must be paid with money that is in the U.S. BUT, most of Pfizer's cash is NOT IN THE U.S. for tax purposes. If Pfizer brings that money back to the U.S. in order to pay the dividend, it will be taxed at a very high rate. I think Pfizer will reduce its dividend before it pays higher taxes just to give a good dividend to little ol' shareholders like me.
    Reply | Link to Comment
  •  
    Jun 27 08:14 AM
    sorry, but i don't understand the author's obsession with moriningstar ratings. their ain't no shortcuts to avoid your own due diligence. these ratings might be some starting point but nothing more.
    Reply | Link to Comment
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