The Dow 30: Priced to Perceptual Perfection

The phrase 'the worst is over' has acted as a crutch for blue chips since late March, and helped facilitate the belief that the Dow has reached a solid bottom. However, has the bottom really arrived?1

1980s Versus Today: Comparing P/E Ratios and Perceptions

While stocks average a P/E ratio of roughly 16 through out history, the Dow currently trades with a P/E average of 29. By comparison, back in 1980 the Dow had a P/E of under 8 before beginning its biggest bull march ever in 1981. The conclusion is that although P/E ratios may be somewhat meaningless and arbitrary, in hindsight the extremes are nearly always predictive of dramatic bull and bear markets.

To claim that high P/E's are the most important statistic Dow investors follow is, of course, silly. For instance, in the early 1980s even as Dow earnings estimates were not met stocks still rose. Meaning that multiples, and stocks prices grew even as the earnings estimates got slashed. As such, could a similar rally unfold today even if current earnings estimates prove insanely high?

The reason why most believe that stocks rallied in the early 1980s was because price/earnings valuations were seen as attractive*, and Paul Volcker had successfully implemented a plan of attack to end the stagflation of the 1970s. By contrast, a different situation could be happening today: price/earnings valuations on the Dow 30 are more than triple levels seen in 1980, and, dependant on which economic numbers you care to focus on, the economic/inflation situation is becoming increasingly worrisome.

To continue the comparison with the 1980s look at those earnings per share estimates made on the Dow 30 at the beginning of 1980 for the period of 1983-1985 versus similar comparisons today. Does this tell us anything?

Value Line Estimates ²	1980 EPS Estimates	Acutal EPS results	Average P/E Ratio
	for 1983-1985	for 1983-1985	from 1978-1980
Acloa	$7.75	$2.27	4.5
Allied Signal	7.2	4.2	7.5
American Can	8.5	4.42	6.5
American Express	5.64	2.96	7
Bethlehem Steel	9	-4.36	5.5
Chevron	10	4.76	5.7
DuPont	8.7	5.13	7.5
Eastman Kodak	7.47	2.51	9.1
Exxon	10	6.66	6.2
General Electric	5.2	4.87	8.4
General Motors	13	12.78	5.3
Goodyear	6.5	3.27	6.1
IBM	9.9	10.16	12.3
Inco Ltd.	5.25	-1.14	14.2
International Paper	9.2	3.07	6.2
McDonald's Corp.	4.55	4.4	10.2
Merck	4.6	3.4	13.6
MMM	9.25	5.99	10.3
Navistar	13	-4.9	4.4
Owens-Illiniois Glass	8	4.14	5
Philip Morris	4.35	4.3	8.9
Proctor & Gamble	6.53	4.7	11.6
Sears, Roebuck	4.2	3.78	8.1
Texaco	9.4	4.5	5.6
Union Carbide	4.17	1.03	5.1
United Technologies	5.25	4.24	7.6
U.S. Steel	8.3	-0.52	6.7
Westinghouse	3.63	3.03	5.3
Woolworth	5.75	2.28	4.5
Average	$7.39	$3.51	7.54

First Call Estimates ³	2001 Consensus	2002 Consensus	Trailing P/E	5 Year Divergence %*
June 13, 2001	EPS Est.	EPS Est
Acloa	$2.07	$2.83	22.3	-1.10%
American Express	2.07	2.42	20.91	-0.7
AT&T	0.22	0.36	NA	13.1
Boeing	3.78	4.42	19.19	-11.6
Caterpillar	2.61	3.42	19.59	20.2
Citigroup	3.02	3.47	19.41	-1.4
Coke	1.6	1.83	36.83	11.8
Disney	0.8	0.96	134.5	9.7
DuPont	1.98	2.61	24.7	4.6
Eastman Kodak	3.89	4.48	11.25	3.5
Exxon Mobil	4.99	4.46	17.9	1.6
General Electric	1.47	1.7	36.61	1.3
General Motors	3.78	4.62	13.58	-7.8
Hewlett Packard	1.05	1.39	24.5	5.1
Home Depot	1.25	1.51	46.04	-3.7
Honneywell	2.65	3.18	28.75	3
IBM	4.84	5.48	25.37	1.5
Intel	0.54	0.78	24.46	0.01
International Paper	0.38	2.2	142.48	-2.9
Johnson & Johnson	3.86	4.37	28.76	1.6
JP Morgan Chase	3.06	3.98	18.07	3.8
McDonald's Corp.	1.49	1.67	21.16	4.1
Merck	3.2	3.51	24.55	-2.5
Microsoft	1.8	1.94	39.27	-20
MMM	4.85	5.53	26.72	6.2
Philip Morris	4.08	4.61	12.53	1.4
Proctor & Gamble	3.11	3.27	24.43	0.1
SBC Communications	2.35	2.6	18.49	5.5
United Technologies	4.09	4.7	21.83	-2.9
Wal-Mart	1.54	1.76	35.47	-4.6

Average	$2.55	$3.00	29.88	1.3333%