Is Dow Chemical Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Dow Chemical (NYSE: DOW  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Dow Chemical's story, and we'll be grading the quality of that story in several ways:

  • Growth: are profits, margins, and free cash flow all increasing?
  • Valuation: is share price growing in line with earnings per share?
  • Opportunities: is return on equity increasing while debt to equity declines?
  • Dividends: are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Dow Chemical's key statistics:

DOW Total Return Price Chart

DOW Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

9.6%

Fail

Improving profit margin

26.6%

Pass

Free cash flow growth > Net income growth

503.7% vs. 38.8%

Pass

Improving EPS

32.2%

Pass

Stock growth (+ 15%) < EPS growth

78.5% vs. 32.2%

Fail

Source: YCharts. * Period begins at end of Q2 2010.

DOW Return on Equity Chart

DOW Return on Equity data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

23.5%

Pass

Declining debt to equity

(22.5%)

Pass

Dividend growth > 25%

113.3%

Pass

Free cash flow payout ratio < 50%

43.3%

Pass

Source: YCharts. * Period begins at end of Q2 2010.

How we got here and where we're going
Dow Chemical put together a really strong performance, earning seven out of nine passing grades, but missing an eighth due to sluggish revenue growth over the past three years. Dow's shareholders have enjoyed solid growth over the past few years, but its share price has outpaced the growth of its bottom line lately. All in all, Dow looks quite solid, but can the company keep up its progress? Let's dig a little deeper to find out.

Fool contributor John Miller notes that Dow produces about 20% of the world's ethylene oxide, and over the past few years, demand for ethylene oxide has grown 5% to 6% every year, and that could increase further if and when emerging markets shake off their doldrums. Dow has also been looking to generate more revenue from its agricultural segment -- in the first quarter, Dow's Agricultural Sciences division reported a 14% growth in revenues. The company is shifting away from several legacy chemicals businesses in the meanwhile, and has divested weaker lines for a total of $8 billion over the past few quarters. My fellow Fool Dan Caplinger notes that Dow has been trying to keep the recent flood of natural gas produced in the United States in the United States, as this input is much lower-priced domestically than it is in much of the rest of the world. If this edge evaporates, Dow may wind up trimming down its product lines even further.

Dow's rival DuPont (NYSE: DD  ) also has plans to move away from the chemicals industry, and now intends to divest its Performance Chemicals division to realign its focus on more profitable businesses, particularly Agriculture and Nutrition. DuPont's Agricultural segment grew 7% in its most recent quarter, and now contributes 37% of the company's total revenues.

Dow's electronics and communication business, which develops materials for smart devices, saw a rather underwhelming year-over-year growth of just 2%, but DuPont's equivalent division reported a 9% drop in sales in the latest quarter. Fool contributor Neha Chamaria points out that 95% of smart devices in the market employ Dow's innovations, which should help the company maintain its grip on what appears to be a business approaching or at a near-term cyclical peak. On the other hand, Dow and Corning's (NYSE: GLW  ) joint venture Dow Corning has been weighed down by oversupply, which is likely to crimp any near-term profit distributions to both companies.

Putting the pieces together
Today, Dow Chemical has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 10, 2013, at 10:57 AM, funfundvierzig wrote:

    Actually, the results of DuPont AG in the most recently reported quarter, Q2 2013, were rather sickly. Operating earnings declined by 1%, and volume sales increased by only a paltry 1%. Last week, Wall Street pundit and portfolio manager, Stephanie Link, in a video interview cautioned that Ms. Kullman, DuPont Chieftess, may be lowering her DuPont AG numbers. Moreover, the multi-$billion Imprelis new product failure continues to blast away at cash flow in DuPont AG.

    Dow Chemical, which is often overshadowed by the much smaller DuPont because of the latter's superior PR and IMAGE campaigns is becoming a true American powerhouse in specialty and commodity chemicals & materials and agriculture. By a number of financial metrics, Dow Chemical is twice the size of the shrinking DuPont Company, and is the world's second largest chemical enterprise, with only BASF ranking higher in the number one position.

    ...funfun..

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