Stuart Shaw, CFA

The most well known and quoted stock market index is the Dow Jones Industrial Average, popularly known as the Dow. The Index is comprised of 30 large capitalization stocks, most traded on the New York Stock Exchange. A representative measure of the U.S. stock market, the Dow spans such diverse industries as financial services, technology, healthcare, retail, entertainment, consumer goods, energy, chemicals, aerospace and construction equipment. The Index also is used in the famous Dow Theory by some technical analysts, and Dogs of the Dow, a more recent investment strategy focusing on the highest yielding Dow stocks.

The Dow is up 6.4% year-to-date and 18.2% from the 52 week low (as of July 27, 2007). Is the Dow overvalued? Are there any potential ideas among the Dow’s components worth investigating in-depth? How are these companies performing? In order to get a handle on these questions and others, I put the Dow through the Company Stock Risk Profile Fast Track™.

Fast Track™ focuses on 10 key categories incorporating the balance sheet, cash flow, earnings, valuation, and how management and the Street feel about the stock. Applying Fast Track™ to the Dow gives us a bottoms-up quick study of the Index, and may yield a few ideas for further research.

I start to get interested in a stock only if it fails no more than 3 of the 10 categories. Only then will I put the stock through the entire Company Stock Risk Profile™ research process for a thorough analysis. All 30 Dow stocks on average failed 4.5 of the 10 categories. Let’s get behind the number.

Eight of the 30 companies reported earnings that were disappointing versus Street estimates in any of the last 4 quarters. But analysts have been lowering earnings estimates for only 3 companies. Are Street expectations too optimistic?

The Dow companies in total throw off a lot of cash. However, free cash flow (cash from operations less capital expenditures) has been declining at 9 companies, and 2 companies have been posting negative operating cash flow. Also, cash and short-term investments on the balance sheet have been dropping at 15 companies.

Fast Track™ favors companies with low or no long-term debt, defined as long-term debt as a percentage of total capital of no more than 20%. While the Dow companies averaged 35.2% for the most recent reporting period, 10 companies were below 20%. At the end of 2002, these same numbers were 39.3% and 8 companies, respectively.

Fast Track™ values stocks using the price / earnings ratio. It asks 2 valuation questions: (1) Is the P/E less than 100% of the average of the high and low P/E’s of the last 5 years? (2) Is the PEG (P/E divided by Estimated Earnings Growth Rate) below both the industry and the S&P 500? Eighteen of the 30 stocks failed both questions.

How does management feel about their stock? Except for Coca Cola, insiders have been net sellers. But Street analysts are buying. Seventy percent of the analysts following 23 Dow stocks are recommending purchase. I like to see less than half the analysts following a stock with buy ratings, and there are only 7.

If the Dow was a stock, it failed my 3 category rule, and I would pass. The earnings and cash flow variables have been showing some cracks. Valuation is not all that attractive. Insiders are selling stock on balance. The vast majority of Street analysts like the outlook for earnings and the stocks leaving less room for upside earnings surprises and ratings upgrades than I would like.

Whether the market is rising or falling, I believe there are always potential stock ideas to discover. The Dow on Fast Track™ uncovered 6 possibilities. They are: Boeing (BA), Disney (DIS), Hewlett Packard (HPQ), Pfizer (PFE), Wal-Mart (WMT) and Exxon (XOM), all failing no more than 3 categories.

The Company Stock Risk Profile Fast Track™ is a research tool for quickly and easily screening stocks for ideas. Whatever screening tool you choose to use, always thoroughly research the stocks that pass your screen.