The year's best performers are headed for a tumble, while three beaten-down stocks are ready to rebound
I believe a vigorous reshuffling of the pecking order in the Dow will happen in the next six to 12 months. I suspect all three of the index's top performers are likely to run into trouble. Better bets, in my judgment, are some of the Dow's laggards this year. Those stocks, I believe, are poised for a break out.
Dupont: FLOP
DuPont Co. is the leading stock in the Dow Jones Industrial Average this year, up 26%. I think the Wilmington, Delaware company will stall out soon. Why? Because the chemical maker can't escape the problem that its earnings rise and fall with the tides of the economy.
DuPont's earnings are unimpressive. In 2001, it made $4.16 a share; if analysts' predictions are right, the company will record a profit of about $3.11 a share this year. Add up all of DuPont's assets and subtract its liabilities. The resulting figure, known as stockholders' equity, was more than $16 billion in 1990. Today, 20 years later, it stands at about $9.3 billion.
As of June 30, DuPont's total debt was 119% of stockholders' equity. I rarely buy stocks where that ratio exceeds 100%. DuPont's stock is recovering from a hideous 2008, when the shares dropped 43%. Gains of 33% last year and 26% so far this year put the shares at about $42. That's in the stock's normal price zone for most of the past decade.
Microsoft: POP
Microsoft Corp., down about 22% this year, is a profit powerhouse. In its last fiscal year that ended in June, it posted a 40% pretax profit margin and a return on stockholders' equity of 44%.
The Redmond, Washington-based company is the world's largest software maker. Not surprisingly, its growth rate has slowed as the company matured. Even so, it has averaged 12% annual earnings growth the past five years. At 11 times earnings, the shares look like a bargain.
Caterpillar: FLOP
Caterpillar shares have jumped about 25% this year. Yet I think it will be a long time before the company again approaches its record earnings of $5.66 a share in 2008. The Peoria, Illinois-based company, which makes construction, agricultural and mining machinery, makes about two thirds of its sales outside the U.S. It benefits when the U.S. dollar is weak because that condition makes Caterpillar's equipment more price-competitive abroad, and increases the dollar value of profits earned outside the U.S.
The U.S. dollar index was generally declining from 2001 through 2007. Since then the index, which measures the value of the U.S. dollar against six other major currencies, has steadied, and this year it's risen. The company no longer has this wind at its back. Caterpillar's debt to equity is more than 300% -- an unhealthy level, in my opinion. And its stock is selling for 29 times earnings, no bargain.
Alcoa: POP
Alcoa Inc., the Dow's worst performer so far this year. also looks attractive. New York-based Alcoa can't seem to get any earnings traction and its stock is down about 31% this year. But with the shares trading at about $11, down from more than $40 about two years ago, I think a bounce back is probable.
Alcoa shares are selling for less than book value, and for only 0.6 times revenue. Those are compelling values. The weak economy and rising electricity costs have hurt the company, but have also driven some competitors out of business. That should help Alcoa regain decent profitability by 2011.
McDonald's: FLOP
As for Oak Brook, Illinois-based McDonald's, I like its food, as my waistline attests. At certain times, I like its stock. This is not one of those times. Currently, the company's shares command a multiple of six times book value (assets minus liabilities per share). That's hardly a value meal.
Hewlett-Packard: POP
Hewlett-Packard Co, located in Palo Alto, California, has been making headlines lately for all the wrong reasons. This month the company filed a lawsuit to block recently departed Chief Executive Officer Mark Hurd from joining Oracle Corp. as its president. HP says the move would violate a non-compete agreement, and that Hurd would inevitably carry HP secrets to Oracle if allowed to work there.
Hurd left HP last month, after an internal investigation cleared him of sexual harassment but found that he had submitted misleading expense accounts. Immediately before Hurd resigned, HP shares traded at about $47. Today, they go for about $38, down about 26% for the year.
At this reduced price, HP fetches about 10 times earnings and 0.7 times revenue. What a favorable price that is for an enterprise that has averaged 23% earnings growth over the past five years, and that earned 19% on stockholders' equity in its latest fiscal year.
[John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. Mr. Dorfman has no long or short positions in the stocks discussed in this column, for clients or personally.]