Dow 36,000 or Dow 3,600?

By: Gregg Jahnke | Wed, Jul 31, 2002
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In the Monday's Wall Street Journal they revisited the work of our analytical opponents, James Glassman and Kevin Hassett, of "Dow 36,000" fame. The authors have no ill feelings regarding their astronomic forecast. In fact, they still stand by their Dow 36,000 prediction, but they are "just not going to give a date." Recall, they based their prognostication on the theory that stocks are less risky than bonds. This premise is based solely on the fact that stocks have enjoyed better average returns historically. There is no regard to the fact that equity shareholders are the last in line should a company declare bankruptcy. Unfortunately, this has not been lost on numerous shareholders this year. The article contained some criticism. Most notably from economist Paul Krugman: "…they may have had one digit too many in their title, lets hope it was an extra 3, not an extra 0." Inspired by this question, and the chance to write a new book called Dow 3600, we did a simple "back of the envelope" valuation of the Dow Jones Industrial Average.

Armed with only a Value Line, a calculator, and some common sense, I set off to value the 30 stocks that comprise the DJIA. Sorry, no fancy dividend discount models that use earnings from the year 2118 to calculate value, just the P/E's and earnings power estimates that portfolio managers use in the real world.

In the majority of cases, I used the 2002 Value Line earnings estimate, but in the case of companies with cyclical earnings I used an estimate of mid-cycle earnings. These earnings were then valued using a P/E multiple that was a generous estimate of their true long-term earning growth potential. The multiple ranged from 15x for the fastest growers, to 6x for one company with little growth potential. For some stocks that had highly volatile earnings, I used estimates of 2002 book value, and applied a reasonable multiple of book value that the stock had traded for in the past. Obviously there is quite a bit of judgment involved, but if you wish to supplement your own opinions the table below can be adjusted to suit your own tastes

Using the first set of estimates, I calculated a "fair value" of the DJIA of 4,216. But as we have all learned, stocks will often sell well below and well above fair value. Additionally, the P/E estimates used in my table could well be too high and the earnings estimates could also be far too optimistic as the double-dip recession sets in. This "fair value" that I calculated of the DJIA is twelve percent of the 36,000 target Glassman and Hassett forecasts. If this was Japan twelve years ago, Glassman and Hassett would likely be forecasting a Nikkei of 100,000, instead of seeing the asset bubble that was about to pop.

Since I am a betting man, I'd say we have a better chance of 3,600 before we see 36,000. Care to wager a few Gold Eagles Mr. Glassman and Mr. Hassett?

The opinions expressed below are those of the author, and do not necessarily represent those of station management. The DJIA is simply calculated by adding together the 30 stock prices and dividing by the divisor which according to Bloomberg is now .1444 ( it was originally 30 when the index was created).

Company Ticker Price to Book Book Value Implied Price Current Price
Philip Morris MO 3 9.50 28.50 $46.05
Intel Corp INTC 2 5.45 10.90 $18.79
Alcoa Inc AA 1 12.90 12.90 $27.05
American Express AXP 1 9.80 9.80 $35.26
Intl Paper Co IP 1 24.05 24.05 $39.82
Caterpillar Inc CAT 1 16.30 16.30 $44.70
General Motors Corp GM 0.5 44.65 22.33 $46.55
J P Morgan Chase & Co JPM 0.5 10.63 5.32 $24.96
Citigroup Inc C 0.5 18.20 9.10 $33.54
AT&T Corp T 0.5 13.95 6.98 $10.18
Sum of Prices using Book Value $146.17 $326.90
Company Ticker Price to Earnings EPS Estimate Implied Price Current Price
Microsoft Corp MSFT 15 1.50 22.50 $47.98
Johnson & Johnson JNJ 15 2.20 33.00 $53.00
Wal-Mart Stores WMT 15 1.75 26.25 $49.18
3M Company MMM 12 4.00 48.00 $125.83
Home Depot Inc HD 12 1.20 14.40 $30.88
Procter & Gamble Co PG 12 3.45 41.40 $88.99
McDonalds Corp MCD 12 1.48 17.76 $24.75
General Electric Co GE 12 1.65 19.80 $32.20
Coca-Cola Co KO 12 1.80 21.60 $49.94
Merck & Co MRK 12 3.13 37.56 $49.60
Disney (Walt) Co DIS 12 0.75 9.00 $17.73
Exxon Mobil Corp XOM 9 2.00 18.00 $36.76
Boeing Co BA 9 2.00 18.00 $41.52
Hewlett-Packard Co HPQ 9 0.80 7.20 $14.15
SBC Communications Inc SBC 9 2.45 22.05 $27.66
United Technologies Corp UTX 9 3.00 27.00 $69.50
Du Pont (E I) De Nemours DD 9 2.00 18.00 $41.91
Honeywell International Inc HON 9 2.35 21.15 $32.36
Intl Business Machines Corp IBM 9 3.00 27.00 $70.40
Eastman Kodak Co EK 6 2.15 12.90 $30.78
Sum of Prices using Earnings $462.57 $935.12
Sum of All Prices $608.74 $1,262.02
Times Divisor: 0.1444 0.1444
Price of Dow Jones Industrial Average 4,215.62 8,739.75

(Alphabetical by company name)


Gregg Jahnke

Author: Gregg Jahnke

Gregg Jahnke
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