Here we are again, with the third installment of our Diving Into the Dow series. If you missed the first two installments, or simply want to refresh your memory, you can find part 1 here and part 2 here.
For those new to this series, it's basically a retelling of the normal banter between me (Stephen) and Foolish colleague Nathan Parmelee -- cleaned up a bit and put into an easier-to-read/less stream-of-consciousness format. This isn't meant to be an in-depth, wall-to-wall research project on all of the merits and drawbacks of each stock. Rather, we believe it accurately reflects how we both go about the initial process of identifying new ideas and prospects. In other words, this is a launching pad for future research, not a bunch of authoritative conclusions.
Both of us think of ourselves as value-focused investors who will look pretty much anywhere and consider almost any type of business so long as it meets our value criteria. Normally, we find our best ideas amongst the undiscovered and neglected small caps and mid-caps of the market. But we've noticed lately that many Dow stocks seem to be trading at or near interesting prices. Accordingly, we thought it might be interesting to take a quick look at them all on a stock-by-stock basis.
Read on as we tour our third collection of some of America's best-known and most widely owned equities:
ExxonMobil
SS: Although Exxon wouldn't be my first choice among Big Oil stocks, I still like it as an income-oriented idea with some capital appreciation upside. This company seems to realize it's in the business of total return for its investors, and the dividend record shows that. Through good oil markets and bad, Exxon has always come through on that standard. Production figures aren't so good right now, but the company has a respectable history of reserve replacement and competitive finding costs. Still, the fate of this stock is linked to oil prices, and Fools have to keep in mind that that can mean above-average volatility.
NP: I think Exxon Mobil took too much flak for spending its cash on repurchases instead of expanding its business. But if you want to buy a big, safe oil company, this isn't a bad idea at all. The company's oil business is strong all the way through, and its ability to refine sour crude should help ensure that margins stay solid. If you believe that oil hasn't yet run its course and are aware that you're buying a slow-growing $350 billion company, it's hard to turn down a solid company with a yield over 2%.
General Electric
SS: What doesn't GE do? With exposure to markets ranging from media to energy, from health care to heavy industry, GE is pretty much a national economy in miniature. As it is so big and so diversified, it could be hard for the company to grow earnings at a double-digit clip for the long haul. Still, I neither love nor hate the stock. There's a good dividend here of 2.5%, and the company's focus on leadership positions in its markets should help support profits and cash flow. I'd probably look for a dip below $30 to buy, but if I already owned the shares, I can't see why I'd sell them.
NP: There are plenty of analysts who are bullish on GE and see double-digit growth for the next three to five years. That's a bit too optimistic for me. I believe something closer to 8% growth is more realistic over that timeframe. That's still a very respectable rate of growth for a $360 billion company, but not one that gets the job done at today's prices. To my eyes, GE is fairly valued around $35 per share. For that reason, I'd wait on GE until its yield exceeds 3% or its P/E multiple falls to around 15. With the regular dividend currently yielding 2.5%, a 3% yield would not require the stock to drop much from here, and such a price point is entirely possible in the next 12 months, considering that another dividend increase from the company is imminent.
General Motors
SS: Maybe the initials "GM" should stand for "generally malodorous." I've got to really wonder what's going on in the minds of management. The strategy here seems to be to cut prices to boost sales and jawbone labor in an attempt to lower costs -- in other words, the same basic approach as the airline industry. Folks, when you're taking notes from the airline industry, you're in trouble.
What does GM do well? It's not on the forefront of new technologies in either production or vehicle design. It's not a low-cost operator, nor is it foremost in styling or performance. What it does have is a huge load of debt and a lot of retirement obligations. Without some pretty drastic changes to the way this company does business, I just don't see any reason to take a chance on the shares.
NP: I hate to malign a company that has more than its share of struggles, but there is really nothing I see at GM that I like. There is value in the GMAC financing business and the international businesses, but so what? I can buy a financial if I want exposure to that industry and Toyota
Hewlett-Packard
SS: HP has shown that it can create some chaos for competitors like Sony and Lexmark, but the company needs to prove that it can once again create shareholder value like it did pretty consistently up until the late '90s. While there were some successes in Carly Fiorina's term as CEO, I question whether HP is, on balance, stronger today than it was in 1999.
A tough price competitor in the market, the company is simultaneously trying to cut its own costs and get margins out of a low single-digit funk. Although the new CEO has a good history with turnarounds, it will be just as important to maintain or improve brand image, product quality, and reinvest in new product R&D. The stock doesn't seem overpriced today, but I don't see much margin of safety, either.
NP: It's tough for me to like Hewlett-Packard. Every line of the business has competitive challenges on price and technology. Printers, PCs, and servers all have competitors eating away at them. There are signs that incoming CEO Mark Hurd is reducing costs and improving cash flow, but at $28 per stub, I don't see the potential for market-beating returns in Hewlett-Packard's shares.
Home Depot
SS: Some Dow stocks are cheaper, but Home Depot is near the top of my buy list. Even if you think the U.S. market is close to full penetration of these big-box home retailers, there's a whole world of opportunity out there. I also must admit that I find the company's nearly 20% return on invested capital to be especially enticing.
Although Home Depot has been a consistent performer, the stock has been anything but. Compared with the end of 2001, revenue is almost 70% higher, and operating income has more than doubled, but the stock is lower. Now, it's certainly fair to say that the valuations back in 2001 were pretty nutty, but even today the stock is slightly cheaper than the broader market.
NP: Home Depot is one of my top 10 picks in the Dow, and back when it was in the $37-$38 range a month ago, it was in my top five. Considering that we both like it, it's not much of a surprise that the company is a Motley Fool Inside Value selection. My only concern with Home Depot, and Lowe's, for that matter, is how much of their business is coming from the now-famous house "flippers" making improvements and how much is coming from regular homeowners making recurring repairs and expansion. Still, I'd have to say that Home Depot is my favorite in this group of five.
Foolish final thoughts
Today we tackled the two largest Dow stocks (by market capitalization) as well as the smallest. We came away liking Home Depot a lot and Exxon Mobil a little, but willing to wait for better prices on General Electric and Hewlett-Packard. As for GM, well . let's just say we're not too optimistic on that one.
We're now halfway through our tour of the Dow and have already found a few potential winners. Looking at the list ahead, I'm sure there will be more to come. Of course, these are only two Fools' opinions -- your mileage may vary, and it's absolutely essential for you to do your own due diligence and make your own decisions.
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Fool contributor Stephen Simpson has no financial interest in any of the companies mentioned. Neither does Nathan Parmelee.
