DJIA ESTIMATES
2/3RDS ARE OVERVALUED IF ANALYSTS AND HISTORICAL PE ARE CORRECT
AVG PE IS 15 - WHICH IS ALSO THE AVERAGE HISTORICAL PE
IF SOLD AT VALUE AVG PE IS 11
14% OVERVALUED
IF AT LOWISH PE OF 9 DJIA WOULD BE DOWN AN ADDITIONAL 40%
CURRENT DJIA 9447.  DOWN 40% MEANS DJIA OF 5668

Here are some estimates that might help you put the stock market in perspective in the weeks and months to come.  From the turn of the century the Dow Jones Industrial Average has had an average ratio between the prices of the stocks in the DJIA and their earnings of about 15.  That means that the price of the these 30 stocks averaged about 15 times their trailing 12 months earnings. 

During the last 11 decades (from 1900-2008) the DJIA PE ratio fell to at or below 10 at least once in 7 of those decades.  That means that the stock market seriously crashed one or more times in two thirds of the decades in the last 108 years. 

It has not crashed that hard since the early 1980s. This means we are way overdue for a big one.

I just toiled away today for a while and calculated the DJIA PE ratio as of today with the stock market at 9447.  The PE on the DJIA stocks is at 15. 

If we get a PE at, say, 9 in the next year, the Dow will be at about 5700.  You ready for that?

You know how I like to value things and compare the value to the price.  A quick and dirty way to value a Dow stock like AXP is to:

1. look at what the analysts are saying on average is the expected next five year growth rate;
2. take the existing trailing twelve months of earnings per share;
3. look up the historically average PE, as long as it's is no more than 2x the growth rate;
4. use 15% as a minimum rate of return;
5. and do the calculation.   

I just did that for the whole Dow.

If the analysts are right about growth, if the PE is reasonable and if the last 12 months earnings are not completely out of whack, then two-thirds of the Dow companies are priced above their real value.

This is not unexpected, since you have 10,000 fund managers buying the same 30 stocks.  Today the average PE ratio on the Dow was 15.  Which means they are priced, at 9447, right at their historical average.  If they were priced at their value as a business, the PE of the Dow would be at 11 right now.

Of course, once the Dow falls down off of 15, it's going to have a lot of momentum based on fear and baby boomers getting their money out of the market to protect their retirements.  If it tumbles much from right here at 9447, expect to see it continue on down into single digits.

It's sickening to see what is happening to so many people who trusted in the "buy and hold" philosophy that they've been brainwashed into believing is a good thing.  Entire retirements are being changed dramatically as we watch this market melt down.  I'm feeling their pain.  But in real life, ignorance of the laws of nature is no excuse, and it is a law of nature that a thing that is priced too high shall come down.  This market has been overpriced for so long that we've forgotten what normal looks like.

Unfortunately we're going to have to wait years to find out what normal looks like, because once the prices fall hard, fear takes over and drives them down farther and farther.  There will be upward runs, but it's going to be a long, long time before "buy and hold" will give you a good return.

You will know when we're at the end of the cycle.  It will be common knowledge that you can't make money in the stock market.

If you've been paying attention, you've either been in cash or got out on red arrows months ago and are in cash now.  I congratulate you.

Now continue to be patient.  The time to load up is coming.  But we're not there yet.  We're going to see things go a lot lower, and then it will be time.

If you are not sure about that, find great businesses and buy them if they are on sale.  Many are not.  But some are.  Buy them and be emotionally prepared to buy more as they drop in the future.  This is the subject of my new book and it is a great strategy.  But you must get the value right.  If you are not sure, then continue to trade nimbly and look out below.

Now go play.