The Dow 30, Volatility And The Validity Of A Filter
When the market corrected in late August, a review of how the DJIA fared prompted me to establish a filter for my investment club to use when considering volatility. The criteria established identified six components for investment consideration. Five months of volatility later and with a new year on the horizon, it is an opportune time to review results. Running the same filter yielded both commonality and difference. Regardless, it reestablished a starting point for 2016. After the August 24th runaway decline (considered by many a correction) in the market, I looked at the DJIA to determine the most attractive 20% of the thirty for my investment club to consider. The criteria for the designation of “most attractive” was designed to both meet club goals and to ascertain the stocks that seemed to best withstand the volatility of the correction. The exercise was not meant to analyze each company or stock but, rather, was designed to establish a starting point for analysis. The factors designed to narrow the field included (and are discussed in more detail in the linked article above): The 50-day moving average could not be more than 25% off its 52-week high; Assuming a correction implies at least a 10% decline, the price must have decreased at least 10%; The price could not have recovered to within 10% of its 52-week high; The price had to bounce or recover at least 50% from August 24th lows; and The company must offer a yield of at least half the DJIA’s average dividend yield. The criteria eliminated seventeen members of the index. The remaining thirteen members were ordered based on potential return. Potential return was derived based on the growth left between current pricing and the lower (to be conservative) of either the 52-week high or analysts’ average one-year target and then added to the annual dividend yield. Interestingly, the club already owned the top four of the sorted remaining thirteen, Proctor & Gamble (NYSE: PG ), Boeing (NYSE: BA ), Apple (NASDAQ: AAPL ) and Cisco (NASDAQ: CSCO ). Buy points on the next six companies were established using a desired 20% gain as a goal. The results were: Component Buy Point 52-Week High or One-Year Target Potential Growth Dividend Potential Total Return JNJ $93.74 $109.49 16.80% 3.20% 20.00% MRK $54.51 $63.62 16.71% 3.30% 20.01% GE $24.66 $28.68 16.30% 3.73% 20.03% KO $38.60 $45.00 16.58% 3.42% 20.00% MMM $140.34 $164.31 17.08% 2.92% 20.00% MSFT $42.74 $50.05 17.10% 2.90% 20.00% What Now? After four months of volatility and with a new year on the horizon, it seems an appropriate time to review the filter. As well, one savvy SA follower suggested: “My guess is if you run this exercise again in a couple of months you’ll get a entirely different answer.” What did investments in the six on the August list return? Would the six still make the cut? Was the criteria used in August effective in determining volatility resistance? Which components would comprise the list for potential investments in 2016? Current Returns The next table displays the returns on the six components from the August list as well as the four companies the club already owned. It was prudent to consider whether a reinvestment was a better option than a new investment. For this exercise, the assumption is that each of the six components was purchased with a limit order at its buy point. On the four stocks already owned, the assumption is the reinvestment occurred at market open August 31st. Component Purchase Date Buy Point December 18th Closing Price Dividends Paid Since Purchase Current Return PG 08/31/15 $71.00 $78.13 $0.66 10.97% BA 08/31/15 $132.37 $139.58 $0.91 6.13% AAPL 08/31/15 $112.03 $106.03 $0.52 -4.89% CSCO 08/31/15 $25.94 $26.27 $0.21 2.08% JNJ 08/31/15 $93.74 $101.95 $0.75 9.56% MRK 08/31/15 $54.51 $51.64 $0.91 -3.60% GE 08/31/15 $24.66 $30.28 $0.23 23.72% KO 09/01/15 $38.60 $42.50 $0.66 11.81% MMM 09/01/15 $140.34 $146.92 $1.03 5.42% MSFT 09/01/15 $42.74 $54.13 $0.36 27.49% As shown, only two of the ten components had a negative return. The DJIA, as a whole, returned 3.63% from August 31st to December 18th. So, seven of the ten filtered components delivered returns better than the index average. Yet, of the top five performers in the index for the time frame, only two are on the list above – General Electric (NYSE: GE ) and Microsoft (NASDAQ: MSFT ). Home Depot (NYSE: HD ), Intel (NASDAQ: INTC ) and Nike (NYSE: NKE ), the remaining three of the five top-performing companies, delivered returns over 36% from the August 24th lows. The New Cut If the same filters are applied to the index based on the closing prices of December 18th, the results do vary. Using the criteria that a stock’s 50-day moving average can not be more than 25% off its 52-week high eliminates Chevron (NYSE: CVX ), IBM (NYSE: IBM ), United Technologies (NYSE: UTX ), Caterpillar (NYSE: CAT ), American Express (NYSE: AXP ) and Wal1Mart (NYSE: WMT ). The second criteria requiring at least a 10% decrease to warrant a correction originally eliminated American Express and Traveler’s (NYSE: TRV ). Traveler’s 52-week low occurred on August 24th. Therefore, using the “correction” definition, the stock has still not “officially” corrected from the August 21st closing price. The third filter eliminates stocks within 10% of their 52-week high. In this iteration of applying the filters, ten stocks are benched – JPMorgan Chase (NYSE: JPM ), United Healthcare (NYSE: UNH ), Visa (NYSE: V ), Johnson & Johnson (NYSE: JNJ ), Nike, Microsoft, Home Depot, Coca Cola (NYSE: KO ), General Electric, and McDonald’s (NYSE: MCD ). Applying the fourth filter of requiring the stock to bounce from its low to within at least 50% of its 50-day moving average eliminated Goldman Sachs (NYSE: GS ). The fifth criteria, a dividend yield greater than the average for the index, eliminates only Disney (NYSE: DIS ) from the remainder. There are eleven components now making the cut – Apple, Merck (NYSE: MRK ), Exxon Mobile (NYSE: XOM ), E.I. Du Pont (NYSE: DD ), Proctor & Gamble, 3M (NYSE: MMM ), Cisco, Pfizer (NYSE: PFE ), Boeing, Verizon (NYSE: VZ ) and Intel. Compared to the original cut, six of the eleven appear on both lists. Finally, only three of the eleven offer a potential return of 20% using analysts’ average one-year target – Apple, Pfizer, and Merck. Once again, Cisco misses the cut by less than 0.3%. Boeing also missed the cut by less than 1%. Yet, the original purpose in late August was to create a list containing 20%, or six, of the DJIA with the most potential based strictly on criteria and numbers. The six companies were then to be the focus of analysis for the coming months by my investment club. Similarly, after months of volatility, the purpose now is to determine how much the list has changed. Because the club already owns three of the top five, Apple, Cisco and Boeing, the next three in the sort will now make the cut. Therefore, the 20% left after the elimination criteria is applied include Pfizer, Merck, Verizon, DuPont, Exxon Mobil and 3M. The 50-day moving averages of the six are not more than 25% away from each 52-week high nor closer than 10%. The dividend yield on each stock is greater than the average for the DJIA. Combining the dividend yield and remaining growth to its one-year target, there is, at least, a 10% potential return. The following table depicts the pertinent data for the six companies not owned by my club as well as the three already owned. 50-Day Moving Average 52-Week High 50-Day MA from 52-Week High December 18th Closing Price One-Year Target Dividend Yield Potential Return Pfizer $32.98 $36.46 10.55% $31.99 $40.53 3.72% 30.42% Merck $53.73 $63.62 18.41% $51.64 $62.67 3.48% 24.84% Verizon $45.50 $50.86 11.78% $45.56 $50.27 4.96% 15.30% DuPont $66.90 $76.59 14.48% $63.40 $69.81 2.29% 12.40% Exxon Mobil $80.21 $95.18 18.66% $77.28 $83.71 3.68% 12.00% 3M $156.49 $170.50 8.95% $146.92 $159.71 2.77% 11.48% Apple $116.61 $134.54 15.38% $106.03 $149.05 1.88% 42.45% Cisco $27.40 $30.31 10.62% $26.27 $30.63 3.13% 19.73% Boeing $146.41 $158.83 8.48% $139.58 $162.83 2.55% 19.21% The next table depicts the buy points established for the list above. As in August, the buy points are established by requiring the potential of a 20% return. Also, as before, to be conservative, the lower of the one-year target or the 52-week high is used. Component Buy Point At or Below 52-Week High or One-Year Target Potential Growth Dividend Potential Total Return PFE $31.35 $36.46 16.30% 3.72% 20.02% MRK $53.78 $62.67 16.53% 3.48% 20.01% VZ $43.69 $50.27 15.06% 4.96% 20.02% DD $59.30 $69.81 17.72% 2.29% 20.01% XOM $71.96 $83.71 16.33% 3.68% 20.01% MMM $136.24 $159.71 17.23% 2.77% 20.00% AAPL $113.90 $134.54 18.12% 1.88% 20.00% CSCO $25.93 $30.31 16.89% 3.13% 20.02% BA $135.23 $158.83 17.45% 2.55% 20.00% Comparing the new list to the list derived in August reveals commonalities. Two of the six components repeat – Merck and 3M. Regarding the companies the club already owns, three of the four repeated – Apple, Cisco and Boeing. While the repetition may appear to reinforce an investment appeal, it is also possible it represents weakness or stagnation. The stocks that were bumped from the list did so because of performance. General Electric’s and Microsoft’s share prices increased over 20%. Coca-Cola and Johnson & Johnson both improved by 7%. Frankly, in the past, my investment club has not been interested in investing in pharmaceutical companies. Based on the potential return of the top two candidates, it may well be time to revisit that hesitancy. The DuPont/Dow Chemical (NYSE: DOW ) merger warrants a deeper dive by the club. Both Verizon and Exxon Mobil represent diversification opportunities to the club. Obviously, the cloud over the oil and gas industry can not be ignored though. Adding 3M to our portfolio would provide a personal triumph as it was my first suggestion when the club formed. And,yet, I’ve never pushed the suggestion. As well, it is equally reasonable to consider reinvestment in the three DJIA components we already own. The club will revisit direction, focus and goals for 2016 early in January. If embracing the DJIA and its volatility is a priority, the list is narrowed and possible buy points established. It would not surprise me to see additional index components in our portfolio by the end of next year.