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.
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:
“It is a matter of comparative indifference with a large operator whether the stock which he is handling is a point or two higher or lower. The thing which is important is whether the public follows up the advances so that he can sell (Dow, Charles H. Review and Outlook. Wall Street Journal. June 29, 1899.)”
The only question now is the selling of the stock. Yes, we can all be long-term holders of stocks. But do we have the temperament for the gyrations that will come? Can we handle see the stock fall back to where we bought it? Have the returns that have been generated from the trade exceeded market returns after taxes. These are now the elements to be mulled over.
For many, Dow Theory has become a means for explaining away realities of the market with little or no emphasis on the core fundamentals of the market. First and foremost, Dow Theory is about values and how they affect the actions of large and small investors. Finally, accepting the reality of fair profits is key, whenever possible. While we can’t also succeed in every transaction, we hope that the above outline has helped to clarify our goal, in general.