In early March, the Dow Jones Industrial Average reached a record high. At that time, many analysts and financial writers were concerned about valuations and the likelihood of a decline in stock prices. Since then, stocks have powered higher, with both the Dow and the broader S&P 500 Index hitting new records. So far this year, the Dow is up nicely, yet the economy continues to grow at a sluggish pace. So, again, we have to wonder if value can still be found in the Dow. Perhaps the easiest way to evaluate the price tag of the Dow components is to examine traditional valuation ratios of companies relative to others in their respective industries. On the basis of key relative valuation metrics, five Dow stocks appear to be attractively priced. The downside to these ratios is that they examine the current price relative to past performance. Stocks are supposed to be priced on the basis of anticipated future performance. Taking into consideration the outlook for future growth yields a slightly different perspective. Upon closer inspection, room for further stock-price gains appears somewhat limited in many cases and value investors need to take special care in identifying opportunities.
I last discussed value stocks in the Dow at the beginning of March. Since then, the Dow has climbed about another 5.5% and is up approximately 15% so far this year. This year-to-date performance is impressive for an entire year, let alone for less than six months. This causes one to wonder if stocks have climbed so much as to limit further gains. One way to explore this possibility is to look at relative valuations. As we saw earlier, there are ten stocks in the Dow that have P/E ratios that are at a discount of at least 15% to their respective industries.
As stated in the earlier article, it might be helpful to consider multiple metrics, not just P/E. P/Sales is also a reasonable choice. And, as we saw last time, there are five Dow components that are priced at a 15% discount to their peers on the basis of both P/E and P/Sales. Moreover, four companies are the same. Construction and mining equipment company Caterpillar Inc. (NYSE:CAT), health insurer UnitedHealth Group Inc. (NYSE:UNH), and oil giants Chevron Corporation (NYSE:CVX) and Exxon Mobil Corporation (NYSE:XOM) all still appear relatively attractively priced, at least at first glance. The only difference in the list is that tech-giant Microsoft Corporation (NASDAQ:MSFT) fell off and financial institution JPMorgan Chase & Co. (NYSE:JPM) joined it. But just because all of these companies currently have relatively low P/E ratios, that doesn’t necessarily mean that they are really all that cheap or that they are good investments right now.
While P/E can provide us with a quick and easy price tag, we should also consider future performance. It is easy enough to simply calculate current stock price divided by the expected earnings for this year, and then see how this compares with others in the industry. But we want to go a step farther than that and compare how the forward P/E ratio compares with estimates for the company’s long-term earnings growth. This yields the P/E-to-growth or PEG ratio. While there is no magic number that makes a stock a good buy, lower values indicate “cheaper” stocks. So, taking into consideration analyst estimates for future earnings, CAT shares have a PEG ratio of 1.2. While these valuation metrics suggest that Caterpillar Inc. (NYSE:CAT) shares remains relatively attractively priced, investors need to consider if global economic activity will pick up sufficiently to stimulate demand for minerals and foment an increase in mining activity, as well as further boost construction above current expectations.
Exxon Mobil Corporation (NYSE:XOM) stock has only edged up since early March. Chevron Corporation (NYSE:CVX) shares have performed a touch better. Currently, ExxonMobil and Chevron both have P/E ratios of 9.3, in an industry where the average is 16.8. But this does not necessarily mean that they are both screaming buys. Looking down the road, analysts have cut their expected earnings growth rate for next year. This is important for investors to keep in mind when examining valuation metrics based on future performance. Taking into consideration analyst expectations, we find that Chevron has a PEG ratio of 4.1, while ExxonMobil is even higher at 5.1. Thus, neither oil company might be the bargain first thought by looking only at the P/E ratio, and the potential for further share-price gains in the near term might be constrained.
UnitedHealth Group Inc. (NYSE:UNH) shares took off in late March, but have, net, lost a little ground since then. Still, the stock is higher since the earlier article, and it currently has a P/E of 11.8 against an industry norm of 20.3. When I last discussed UnitedHealth, it had a PEG ratio of 0.8. Based on current analyst estimates for future earnings, UnitedHealth has a PEG ratio of 1.01, which is still low enough to appeal to value investors.
This brings us to the one change in the list. Microsoft Corporation (NASDAQ:MSFT) shares had been trending relatively flat until mid-April, but then went on a tear. The rally pushed the valuation higher, and the stock is no longer the bargain it was in early March. The stock that appears to be more cheaply valued is JPMorgan Chase & Co. (NYSE:JPM). Shares have slipped since early March. This decline gives JPMorgan stock a P/E of 8.8 versus an industry average of 14.5. Based on expected future performance, JPMorgan has a PEG ratio of 1.23, which is still low enough to appeal to many investors. Yet, one needs to recognize other dynamics that are affecting JPMorgan Chase & Co. (NYSE:JPM), as well as some of the other big banks. Fool Kyle Colona recently highlighted some of the legal and regulatory issues affecting these key players. Some investors may find current valuations appealing. More conservative types may prefer to wait for better clarity on some of these other issues.
In sum
The Dow has been on a tear. Although a handful of Dow members appear to still be cheaply priced on the basis of key metrics, such as P/E, closer inspection suggests that first impressions may be somewhat misleading. Given the lofty PEG ratios, further gains in Chevron and ExxonMobil may be muted. Value investors may want to take a closer look at UnitedHealth and, cautiously, Caterpillar Inc. (NYSE:CAT) and JPMorgan Chase & Co. (NYSE:JPM).
The article Re-examining Value in the Dow originally appeared on Fool.com and is written by Erik Dellith.
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