The
Dow Approach
The
Dow Approach
| Dow Dividend Strategy | What's Here | The Statistics Center | Spin-Off Help | The Archives | |||||||||||||||||||||||
FOOL GLOBAL WIRE LEXINGTON, KY. (Mar. 12, 1997) -- I hate even to bring it up, because I remain a firm believer in the Dow High-Yield approach, but since I've received so many e-mails asking, here goes. What about Price/Earnings ratios? In his book Beating the Dow, Michael O'Higgins tested a number of primary screens before settling on the High-Yield screen as the best single factor when looking for Dow bargains. And the High-Yield approach has been verified again and again by other sources. But the research we've done here in The Fool points to certain occasions when the highest-yielding stock may be a weak choice. The Foolish Four approach automatically skips the cheapest stock of the ten highest yielders for this reason and the Unemotional Value approach skips that stock if, in addition to being the cheapest of the ten highest-yielders, it also sports the highest yield of the ten. Historically, stocks in that position have often proved to be weak compared to the rest of the high-yield group. But what about P/Es? By themselves, P/E ratios aren't more attractive than the yield screen, but occasionally someone will bring up Peter Lynch's version of the P/E and Growth formula and the debate opens up again. Lynch contends that one fine way to value large-cap stocks is to add the yield to the Long-Term Growth Rate of a stock's earnings and divide the sum by the current P/E ratio. A result equal to one represents fair value. A value over two is what one really wants to see. (This ratio is simply an inverted version of what we call the Fool Ratio, with the dividend yield factored in.) The problem with this theory, of course, is getting historical growth rate estimates to test it. It's possible to test it using historical growth rates instead of estimated rates (the method Lynch implies he uses in his book, One Up on Wall Street). The reason I open this can of worms, however, is the curious fact that the current stock both the Foolish Four and Unemotional Value would skip today, AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> happens to present the most attractive stock based on Lynch's ratio. With a P/E of 9.8, a dividend yield of 3.7% and an estimated long-term growth rate of 10%, the ratio is 1.4 for AT&T. While still not as high as Lynch's goal of 2, it nevertheless represents the best ratio of the 30 stocks. INTERNATIONAL PAPER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IP)") else Response.Write("(NYSE: IP)") end if %>, the stock in the favored #2 slot, on the other hand, sports a P/E ratio of 41.5, but only a combined growth rate and dividend yield of 9.3, giving us an ominous 0.2 ratio on the Lynch scale. My point in bringing this up, believe it or not, is not to muddy the already murky waters, although I fully expect that to happen. The fact that there's no clear-cut mandate to keep or cut AT&T the more data you look at reinforces my long-held contention that this isn't perfect science. The Dow Approaches are simple and identify a handful of likely candidates for the coming year. There's no guarantee it's right in every case. The best plan for any Dow investor is to decide on one of the many variations and then use it with discipline. The more details you begin to look at, the more likely it is that you'll become paralyzed by indecision and the desire to tinker around the edges on a stock-by-stock basis. Think through your own situation carefully and then choose the technique most appropriate to create your masterpiece. Small imperfections in the marble or tiny flecks of paint out of place don't mar the overall beauty of the artwork. But if you try to switch media in mid creation, you're likely to create an eyesore (or get an exhibition at MOMA, one or the other). Be Foolish!
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. |
|
||||||||||||||||||||||
|
|||||||||||||||||||||||
|
