Valuing the Dow Jones - 2/17/2009

Not long ago the Dow Jones was actually an Index - something that serves to guide, point out, or otherwise facilitate reference - of the US Economy. Each component was selected because of its size and importance in its industry. Those industries were selected based upon their importance to the overall US GDP. Some industries would grow and some would stall, even shrink during any given period of time. And each Component's share price behaved with great independence of other component's share prices. That combination of similarities (importance to the US Economy and core industries) and independent price action created an elegant barometer of the stock market which is the great predictor of the US economy 6 months out.

But that is not what the Dow Jones Index has become. The moment traders and investors could buy or sell all shares in the index at once, through the DIAA shares, the Dow Index stopped being a leading indicator and became a current emotional indicator. It trades much like the T-Notes - it is a current events driven index. Which makes it a lagging indicator. When will it stop falling? I think we are getting close because the Price earnings multiples (the value of the current share price / LTM earnings per share) are getting closer to parity. 8x - 14x is still a big spread, but most are between 8x and 10.5x.

So let's bring this back to value. Your value. The value of a company to its investors is its predictable future earnings. The value of a company to a buyer of the company is its Net Assets plus its predicted future earnings. Everything else is speculation. So as a business owner, your business model must be fine tuned to create predictable earnings with unencumbered assets. For the public company Executive your goal is to create predictable earnings. That is it. All other metrics, revenue multiples, revenues per customer, multiples to EBITDA, Discounted Cash Flow to name a very few. These "methods" of determining value were created by finance underlings to justify speculative investments or over valued acquisition pricing.

Let that sink in. If building value is your goal, and it should always be, focus on what is real, earnings from unencumbered assets. And let your investors or potential buyers speculate on your real value.

Build value every day.

Brad van Siclen



Here's the other issue.