Monday, August 8

Month 133 - Dow Jones Transportation Average - August 2022

Situation: We’re in a Bear Market. But when will the next Bull Market start? The time-tested way to answer that question is to apply Dow theory, which requires that evidence of an uptrend in the Dow Jones Industrial Average be confirmed by evidence of an uptrend in the Dow Jones Transportation Average. 

The idea behind Dow theory is simple: when economic activity starts to recover, that recovery has to be reflected by companies in the transportation sector getting more business. The trick is to define an “uptrend” in price-action for each of those market averages. Why is that a trick? Because those movements will always a) be halting, b) often backtrack, and c) rarely coincide. You (the investor) will have to plot (or download) the price-action over time for both averages, then draw two lines on each plot: one connecting the valleys that mark downward movements, the other connecting the peaks that mark upward movements. Decide if there's a beginning uptrend in the Dow Jones Industrial Average, then decide whether or not it is being confirmed by a beginning uptrend in the Dow Jones Transportation Average. The Bear Market has ended when both answers are “yes.”


Since price-action in the 20 companies in the Dow Jones Transportation Average determines when you’ll next open your wallet, a good idea would be to know those players and the positions they play. By doing that, you’ll soon notice that air transportation, ground transportation, and water transportation are separate games. The good news is that information technology has brought those together and created a fourth game, called third-party freight forwarding or 3PL (3rd-Party Logistics). Information is an end in itself.


Mission: Use our Standard Spreadsheet to analyze the Dow Jones Transportation Average.


Execution: see Table of 20 companies.


Analysis: Warren Buffett’s favorite metric is addressed in Column V of the Table: Return on Tangible Capital Employed. He thinks anything higher than a 20% return for the last fiscal year (lfy) is a good number. Six of the 20 companies meet that standard: ODFL, EXPD, MATX, LSTR, CHRW and UPS. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar reports (see Column AQ) and is negatively impacted by the degree to which managers choose to capitalize their company by issuing long-term bonds instead of common stock (see Column Z). The 4 major airlines are the only companies assigned a BUY rating from Morningstar (UAL, LUV, DAL and AAA) but 6 companies have a Long-term Debt to Equity ratio that is less than 1.0 (ODFL, EXPD, MATX, LSTR, JBHT and KEX). Mr. Buffett also states that a high Free Cash Flow Yield (Column L) reflects good management because Retained Earnings allow the company to expand operations (or pay down debt) at zero cost. Nine companies (UNP, CSX, NSC, ODFL, EXPD, MATX, LSTR, UPS and FDX) have Free Cash Flow left over after paying dividends. His third point (that the stock be available “at a sensible price”) is addressed by the 1 year and 3-5 year Forward PEG ratios (see Columns Q and R): Only 2 companies have PEGs under 2.0 at both time points (LUV and FDX). Four companies (ODFL, EXPD, MATX and LSTR) are cited 3 times.


Bottom Line: These are high risk companies, with an average 5-yr Beta of 1.25. Only the freight forwarders (EXPD, LSTR and CHRW) have less price volatility than the S&P 500 Index (Column C in the Table). And only one company (UPS) is A-rated (see Appendix).


Risk Rating: 7 (where 10-yr US Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10). Four of these companies have “risk-off” investment potential per quantitative analysis shown in Columns S-U: NSC, LSTR, JBHT and UPS


Full Disclosure: I dollar-average into UNP and UPS.


Appendix: Current requirements for a company to be A-rated are to 1) be listed in the portfolio of the Vanguard High Dividend Yield ETF (VYM); 2) have the 16-yr trading history required for quantitative analysis by the BMW Method; 3) issue corporate bonds rated A- or better by S&P; 4) issue common stock rated B/M or better by S&P; 5) have shown earnings growth for the trailing twelve months; 6) have a positive Book Value for the most recent quarter; 7) have capitalization from issuance of corporate bonds that is no more than 2.5 times equity (i.e., capitalization from issuance of common stock); 8) have a 10-yr Total Rate of Return (Column F in the
Table) that exceeds the long term (16-yr) Required Rate of Return (Column D in the Table).

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