Valuing the Dow: A Bottom-Up Approach

We use a bottom-up approach to estimate the intrinsic value of the 30 stocks in the Dow Jones Industrial Average. In recent years, traditional aggregates market multiples (e.g., book to price, earnings to price) have had little predictive power for overall market returns. We show that an aggregate value-to-price ratio, in which 'value' is based on a discounted residual income model, has statistically reliable predictive power, not only for returns on the Dow but also for returns on the S&P 500 Index and, for a small-stock portfolio. We discuss the implications of these, findings, for tactical asset allocation strategies, the current level of the U.S. equity market, and the issue of equity valuation in general.