DJIA Earnings Weakness and Energy Stocks
With earnings season officially coming to an end analysts and investors are nervous about the lack of growth. Initial attention is on the S&P 500, which has demonstrated a year over year growth rate of 1.05% according to our observations, but that includes recoveries from companies like Transocean LTD (NYSE:RIG) who had significant losses in the year ago period. Without those companies, who are not actually growing but only recovered from the massive losses from a year ago, the S&P 500 would have negative earnings growth to go along with the 5.54% contraction in revenue this quarter.
With all the attention paid to the S&P 500 I thought it best to look at the Dow Jones industrial average to get a better perspective on that market. We track the Dow Jones industrial average on a fair value basis regularly, updating it every day for clients, and observing where fair value exists for the Dow Jones industrial average accordingly. It starts with a raw data, similar to the raw data referenced above for the S&P 500, and that observation tells us that companies in the dow Jones industrial average contracted earnings by 10.97% and revenue by 10.88% this quarter when compared with the same period a year ago.
However, that is not a completely fair observation in our opinion, so instead of including direct comparisons using one off quarters we prefer to use trailing 12 month observations on a Q/Q basis. For example, this quarter would comprise this and the prior 3 quarters to get the data used for comparison, and we would compare that to the trailing 12 month data from the third quarter of 2014 to get accurate growth measures.
Our conclusion is that the rate of growth in the Dow Jones industrial average has been declining steadily since the second quarter of 2014. This is essentially when the stimulus efforts came to an end. You can call that coincidence if you want to, but if you have been reading my work you know what I think about the stimulus efforts. The deterioration in earnings growth has led us to where we are today, and using that trailing 12 month observation the Dow Jones industrial average is contracting by 4.76% on an earnings growth basis.
Fingers will clearly be pointed to Chevron Corporation (NYSE:CVX) and Exxon Mobil Corporation (NYSE:XOM) for rationale, but the growth rate of the other companies in the Dow Jones industrial average does not appear stellar.
Taking a raw look at earnings, there absolutely seems to be a peak in the net earnings per share for the Dow Jones industrial average dating back to 2013, but since then the deterioration in earnings has gone largely ignored or at least discounted by Wall Street.
In fact, looking ahead to next year analysts are currently expecting earnings growth of 7.77% from the companies in the Dow Jones industrial average, which would put earnings growth back in line with where it was before the deterioration we have seen over the past two years, so although there are concerns analysts are still relatively optimistic about next year.
With all that said, when it really boils down to it it's about valuation and our objective is to determine whether or not there is value in the Dow Jones industrial average. Our conclusion is that currently there is no value in the Dow Jones industrial average and even if the Dow Jones industrial average improves earnings growth at a rate in line with analysts' estimates for 2016 there still would not be an attractive value in the Dow Jones industrial average on a peg ratio bases. If analysts are right about their growth rates for 2016 the peg ratio of the Dow Jones industrial average will only improve to 1.8. It is currently negative, given the negative earnings growth rate, but our assessment of fair value is when a peg ratio is between 0 and 1.5, so if the dow Jones industrial average fails to meet expectations it will stretch the already higher relative valuations that we have identified for the dow Jones industrial average in 2016.