UNP: What to Watch

On January 26, 2016, we posted an article about Union Pacific Corporation (UNP).  In that article, we made the case for the stock based on the distinction between a parabola and stock cycles.  The basis for our claim lies in the work of Charles H. Dow’s view on how and when to use market data.  According to Charles Dow:

"The point of importance for those who deal in industrial stocks is whether the capitalization of the companies into which they propose to buy is moderate or excessive, when compared with the aggregate earnings of the various concerns forming the combination in a period of depression. It is probable that consolidated companies will be able to earn as much in the next period of low prices as the companies forming the combine were able to earn in the last one; hence the very foundation of investments in industrials should be knowledge of what these companies earned, say in 1893 to 1896, making, perhaps, reasonable allowances for economies under consolidation. Where the earnings so shown would have provided dividends for industrials now active, the fact must be regarded as a very strong point in favor of those stocks (George W. Bishop Jr., Charles H. Dow: Economist, Dow-Jones & Company,Princeton, 1967, page 11.)"

Essentially, Dow suggests that the most compelling data is derived from when the stock experiences its worst performance, generally during a prior recession or depression low.  Looking at UNP from 1980 to 2015, we determined that the six periods (from peak to trough) in the stock price was more instructive than taking into account the entire period as a whole.  Our conclusion:

“The repeated pattern of declines greater than –30% is no coincidence.  These are the apparent cycles that UNP happens to experience. Furthermore, the level of consistency for UNP to decline on average –48% over the period from 1980 to 2008 (7 data points) indicates that this is very useful in determining what is “normal” for the current decline in the stock price.  Already UNP has fallen –43.16% which is generally in the sweet spot as we believe that the 2008 and 1980 declines were outliers in especially painful recessions.”

Since our January 26, 2016 article, Union Pacific Corporation (UNP) has increased in price by +57%.  Now, it must be said that such astronomical returns by a hum drum railroad company should not be expected to be normal.  At some point, there will be a reversion to the mean which includes the possibility of the stock price stagnating while the Dow Jones Transportation Index increases or declines at a greater rate than the Dow Jones Transportation Index in the next bear market.  That being said, let’s look at what to watch going forward.

Using Dow Theory with Helmerich & Payne

The core of Dow Theory is the emphasis of value investing, anticipating investor behavior and knowing when to accept fair profits.  This posting outlines the basic premise of these core concepts.

On September 14, 2015, we posted a Quick Take of Helmerich & Payne (HP) with the following thoughts:

“If HP were to achieve a similar –77% decline as the period from June 23, 2008 to December 4, 2008, HP would fall to the $27.29 level.  We advise that investors consider HP at the ascending $39.43 level or below.”

“The dividend payout ratio is a decent indication of the best times to consider a stock.  Whenever the dividend payout ratio exceeded 80% [of] the price, Helmerich & Payne was at a relative low.  Already, HP is at a payout ratio of 91.67% based on estimated 2015 earnings of $3.00 per share.”

This commentary is essential as investing is really about values.  As Charles H. Dow has said:

"The one sure thing in speculation is that values determine prices in the long run. Manipulation is effective temporarily, but the investor establishes price in the end.  The object of all speculation is to foresee coming changes in values. Whoever knows that the value of a stock has run ahead of price and is likely to be sustained can buy that stock with confidence that as its value is recognized by investors, the price will rise (Dow, Charles H. Review and Outlook.  Wall Street Journal. February 25, 1902.)."

Unfortunately, most writers on the topic of Dow Theory fixate on chart patterns while ignoring values and then call it Dow’s Theory.  Suffice to say, we made a purchase of Helmerich & Payne on January 12, 2016 and on January 20, 2016, Helmerich & Payne achieved a new 52-week low, nearly –7% below our purchase price.

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Our purchase was predicated on the belief that:

“The thought with great operators is not whether a price can be advanced, but whether the value of property which they propose to buy will lead investors and speculators six months hence to take stock at figures from ten to twenty points above present prices (Dow, Charles H. Review and Outlook. Wall Street Journal. July 20, 1901.).”

On July 2, 2016, we reviewed the price performance of Helmerich & Payne with the following commentary:

“As can be seen in Edson Gould’s Speed Resistance Line (SRL), Helmerich & Payne did decline below the ascending $39.43 level on January 20, 2016, nearly 3 months after the initially posted article.”

“…the most pressing level to watch for is Dow Theory’s 50% Principle which measures the rise (or fall) of a stock at the halfway point between the prior major move.  In the case of Helmerich & Payne, the halfway point of the last major move (July 2014 to January 2016) is at $79.16 which is illustrated below.”

Achieving our target of $79.16 based on Dow’s 50% Principle (which front-loads investor expectations) prompts the following thoughts from Charles Dow:

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Transaction Alert

We executed the following transaction(s):

Dogs of the Dow – A Look Back at 2016 & Forward to 2017

The term a "rising tide lifts all boats" was certainly fitting for 2016. The bull market raged on bringing most investment strategies, except for shorts, into the black.

One should expect to see a good deal of profits from the past "Dogs of the Dow" and "Dogs of NLO" strategy. We truly enjoy keeping track and assessing various strategies. What we did several years ago was introduced our readers to a strategy we termed "Dogs of NLO" which looked at the top 10 Dow Jones Industrial Average stocks that are closest to their yearly low. Contrast that to the conventional "Dogs of the Dow" which focus solely on the high yielding stocks.

Our argument is that these companies are typically clustered into several industries that has high payout ratio while leaving other companies out. As value investors, we put heavy focus on relative value versus absolute yield. That being said, we return to 2013 where we introduced the strategy.

To our surprise, the 10 companies in "Dogs of NLO" outperformed the traditional strategy by +16%. The average annual return for our strategy was +15.8% compared to 11.7%. The table below highlight the breakdown between price performance and yield-on-cost.

Dog_of_NLO

Dogs of the Dow 2013
Ticker Company Beginning of 2013 Price End of 2016 Price 2012 - 2016 % Chg Current Yield on Cost
T AT&T, Inc.         33.7         42.5 26.4% 5.8%
VZ Verizon         43.5         53.4 22.8% 5.3%
INTC Intel         20.5         36.3 76.8% 5.1%
MRK Merck         41.2         58.9 42.9% 4.6%
HPQ Hewlett-Packard         14.0         14.8 5.7% 3.8%
DD E. I. du Pont         45.1         73.4 62.9% 3.4%
PFE Pfizer Inc.         25.1         32.5 29.2% 5.1%
GE General Electric         20.7         31.6 52.7% 4.6%
JNJ Johnson & Johnson         70.1       115.2 64.4% 4.6%
MCD McDonald's         88.7       121.7 37.2% 4.2%
  Dog of the Dow Average   42.09% 4.65%
Dogs of the NLO 2013
Ticker Company Beginning of 2013 Price End of 2016 Price 2012 - 2016 % Chg Current Yield on Cost
MSFT Microsoft         27.0         62.1 130.5% 5.8%
MCD McDonald's         88.7       121.7 37.2% 4.2%
INTC Intel         20.5         36.3 76.8% 5.1%
DD E. I. du Pont         45.1         73.4 62.9% 3.4%
AA Alcoa         20.0         28.1 40.4% 1.8%
IBM IBM       192.7       166.0 -13.9% 2.9%
UNH UnitedHealth         54.4       160.0 194.0% 4.6%
KO Coca-Cola         36.4         41.5 13.8% 3.8%
MRK Merck         41.2         58.9 42.9% 4.6%
CAT Caterpillar         87.7         92.7 5.8% 3.5%
  Dog of the NLO Average   59.04% 3.97%

Although we would welcome +46.70% return of "Dogs of the Dow" strategy, we can't ignore the performance of our strategy which pulled in +63% total return.

One interesting observation was the relatively low dividend yield for "Dogs of NLO" in 2013 (2.90%) compared to the Dow (4%). However, by the end of this year, the yield for our strategy is not too far behind. We won't attempt to dissect the driver for this outperformance as it would be foolish for us to do so.

Now, let's explore the list published last year. The performance of our list was on par with the traditional strategy. There's only one way to find out the viability of this strategy and that's to revisit it several years from now.

Dog_of_NLO_2016

Dogs of the Dow and NLO for 2017 Continue reading

Bitcoin: Hits Our 2015 Upside Target and 2017 Downside Targets

On January 1, 2017, we said the following:

“The $1,051 upside target appears to be within reach as the digital currency is currently trading around the $1,006 level.  It is at this time that we need reassess the prospects for Bitcoin both on the upside and the downside.  Starting with the latter, we have posted the downside targets based on the most recent price indicated.

“As we’ve indicated in the past, the downside targets are paramount as they are the best assessment of the risk a speculator or investor might be taking when they decide to take the plunge.  As highlighted on the chart above, the downside targets are as follows:

  • $772.12 (conservative)
  • $553.75 (mid range)
  • $335.39 (extreme)

“Anyone considering being involved in Bitcoin for speculative or investment purposes should readily accept that the extreme downside targets are always in play.  This means that if you’re going to be involved in this currency you should always keep a portion of funds available for the prospect of the downside risk or accept that all funds invested could take a severe decline.”