When people refer to what the stock market is doing, they are more often than not speaking about the Dow Jones Industrial average.  This leading index of 30 high profile stocks serves as a proxy for the overall health of both the economy and the stock market.  We have long held that thinking in generalities, runs the risk of causing people to paint all common stocks with the same broad brush.

When dealing with averages, like the Dow Jones Industrial Average, the numbers we associate with it represent an average of the whole group. It’s important to remember, that the individual companies or components can have materially different results and even attributes than what we glean from the average itself.  Therefore, if the average (the index) has done poorly, people tend to associate poor performance with all equities.  However, in truth, there are major differences between one company to the next.

Our research confirms that generalities regarding dividends and returns are mere prejudices. Even though it takes more effort to conduct rigorous research than statistics alone can provide, we believe the insights and the rewards are ultimately worth it. F.A.S.T. Graphs™, our powerful “tool to think with”, was designed to easily facilitate a more extensive research process.  Since the Dow Jones Industrial Average only contains 30 stocks, it’s a relatively easy and straightforward process to dissect this index, which is commonly used as a proxy for the “market”.

The 10 Best Performers of the Dow 30 Since 1995

In this Part 1 of this 3-part series on Dissecting the Dow, we will look at the Top 10 best performing of the 30 Dow stocks since 1995 (16-plus years) through the lens of our fundamentals-based research tool.  We chose this time frame, as you will soon see, for an important reason. The year 1995 was a period where most companies in the Dow were reasonably valued, and this date was just prior to the so-called “irrational exuberant period” that ended in the spring of 2000. For a clearer perspective on returns, the performance charts compare the company’s performance to the S&P 500.

Interpreting the Earnings and Price Correlated F.A.S.T. Graphs™

The ability to look deeper into specific stock valuations beyond a mere market average, is one of many reasons that motivated us to develop our F.A.S.T Graphs™ (Fundamentals Analyzer Software Tool™). We wanted specific research, rather than relying on often miss-leading statistical references. Our F.A.S.T. Graphs™ allow us to evaluate the specific sources of long-term investor returns on over 17,000 symbols.

We use three formulas for determining valuation:  For companies growing earnings at 15% or better, the graphs utilize a PEG ratio (PE equal to Earnings Growth Rate) calculation for value (marked PEG in orange ink). For companies growing earnings at 5% or less, the graphs use Ben Graham’s formula for value. These graphs are (marked GDF in orange ink) followed by the number that represents the value PE ratio. For companies growing earnings between 5% and 15%, the graphs use a modified version of the first two (marked in orange ink GDF-EDMP) then again followed by the number representing the calculated value PE ratio.

Therefore, the orange line with white triangles represents fair value for each respective company. In other words, when the black price line touches the orange earnings justified valuation line, the stock is theoretically in value. Prices above the orange fair value line indicate overvaluation and prices below the orange fair value line indicate undervaluation.

Keep in mind that fair value does not necessarily imply high or good returns. Slow earnings growers, even when bought in value will, all other things being equal, generate lower returns than faster growing companies bought in value. However, and most importantly, notice how price and earnings correlate on each graph over time (i.e. the trend line movement of price follows earnings).

A Snapshot Summary of Valuation

The following table lists the 10 best performing Dow stocks in order of highest to lowest performance since calendar year 1995.  For each company the table shows the annualized total return, dividend yield, current price earnings ratio, and for a first perspective on valuation, the normal PE ratio that the market has historically applied to the company.

For a second perspective on valuation, the table is color-coded depicting each company’s current valuation.  When a stock is considered fairly valued, it means that its price is at or near its orange earnings justified value line, and therefore it’s colored orange.  When a stock is considered undervalued, it means that its price sits below the orange earnings justified value line, thereby falling into the green shaded earnings area, and it’s colored green.  If the stock price is above the orange earnings justified value line, it’s considered overvalued, and color-coded red implying potential danger.

The table shows that one company, International Business Machines (IBM) is fairly valued, one company McDonald’s Corp. (MCD) is considered overvalued, but only modestly so, and the remaining eight are considered undervalued.  Consequently, the vast majority of the 10 best performing Dow Jones stocks appear to be excellent candidates for investment consideration at today’s low valuations.

The Best Businesses Produced the Best Returns

As you will see, each of the following 10 best performing Dow Jones stocks produced operating earnings growth that was significantly greater than the 6.7% earnings growth of the S&P 500.  And, even though 8 out of 10 of these excellent blue-chip businesses are currently undervalued, they all produced double-digit returns for their shareholders since calendar year 1995.  This is in stark contrast to the S&P 500’s 7.2% return and significantly above the average of the Dow Jones Industrial Average itself, which each is a part of.

It’s also important to reiterate that the year 1995 was chosen because this was the most recent year where sound valuation existed for most companies and indices.  Consequently, one of the most important variables of sound investing was close to being equally applied in each example.  Therefore, investment results are more fairly measured and correlate more closely to business results.  This is the essence of Ben Graham’s famous market metaphor where he states: “In the short run the market is a voting machine, but in the long run it’s a weighing machine.”

It has long been, and remains, our contention that the only fair way to evaluate the merits of common stock investing is when you measure them when fair value is evident at the beginning of the period.  Otherwise, valuation bias can distort not only the results, but also the reviewer’s attitude and perspective towards the virtues of investing in common stocks.

As an aside, we believe all the nonsense about the lost decade is mostly attributed to ridiculous overvaluation and not the common stock asset class itself.  Our motto is: “Measuring performance without simultaneously measuring valuation is a job half done.”

Pictures of the Dow Top 10 Performers Since 1995

As you review these Top 10 performing DJIA stocks, there are several important characteristics that we would like to draw your attention to.  First of all, you should notice that each of these companies produced operating results that were higher than the 6.7% average of the S&P 500.  Since they were all reasonably valued in 1995, it is also logical

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