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Could Boeing (BA) Ground the DOW?

Tuesday, January 23rd, 2018

When looking at stock market returns, many investors point to the DOW as a comparison or a benchmark for the overall stock market. One problem is many investors are unaware of how the DOW functions. The DOW is a price weighted index with 30 different companies. A price weighted index provides companies with higher stock prices, a larger share of the overall index. This means a company like Boeing (BA) trading at over $300/share occupies much more of the index than a company like GE, which now trades under $17/share.

Over the past year this has been a huge benefit for the DOW as Boeing saw a rapid appreciation of 89% in 2017 and GE saw a large decline of 45% for the year. Boeing has also begun 2018 in full flight as the company had gained 19% through Wednesday’s close. While this sounds great, the problem is this company’s rise alone accounted for 28% of the DOW’s 5.7% year to date rise. If you factor in United Health Care (UNH), another high-priced company at $245/share, these two companies account for 36.9% of the DOW’s rise yet only account for 7% of the total number of companies in the index. This means if high-priced companies slow down or reverse and the low-priced companies advance the DOW’s returns would suffer.

At $336, Boeing is the largest component of the DOW. The company’s rise has come amongst rising expectations for manufacturing and an improving economy, which would be major benefits. Boeing currently operates in the Aerospace/Defense Products and Services Industry as it manufactures and services commercial planes for airlines, military aircraft, satellites, missile defense, and other products.

With the huge appreciation in the stock price, the valuation ratios have now become a concern. The current P/E of 31.1 is above the industry average of 26.5; Price/Sales of 2.2 is expensive when compared with the industry average of 2.0; and Price/Cash Flow of 23.1 is unfavorable compared to the industry average of 18.2. The Price/Tangible Book Value is not material which means if you remove the intangible assets from the balance sheet, the company is left with no equity. This means as an investor you must understand those intangible assets to see if they present a risk.

As an investor you get a decent dividend yield of 2.0% and the company uses just 23% of earnings to pay out that dividend. This is a strong payout ratio and shows the dividend is sustainable moving forward as long as those earnings over the last 12 months did not come from non-recurring items.

With the rapid appreciation in stock price, I am surprised to see revenue has declined by 3.7% over the last 12 months. EPS on the other hand increased 65.4% during the same time frame. This EPS growth is likely not completely attributable to cost cuts, so it is important to understand how earnings climbed dramatically with sales falling.

The balance sheet looks problematic. The current ratio of 1.2 is good, but the quick ratio of 0.4 is concerning. This is a result of the company having a lot of inventory. In Boeing’s case, the inventory for planes is very expensive which drives up the price of inventory on the balance sheet and distorts the quick ratio. Often, I feel comfortable with a low quick ratio for a company like Boeing, but it is a measurable to keep an eye on. The problem with the balance sheet stems from a Debt/Equity that stands at 991.53%. I begin to feel uncomfortable with a Debt/Equity of 100%. One of the company’s segments is Boeing Capital, which could distort this Debt/Equity number. It would be important to investigate if the company has financing on the balance sheet and if so how much debt is due to the other operating segments.

If we look out to December 2018, estimated GAAP EPS of $12.95 would give us a target sell price of $213.68. With Boeing reporting earnings next week, we will be shifting our estimated earnings to December 2019. However, even if we look to that period the GAAP EPS estimate of $15.47 would give us a target sell price of $255.26. These lofty valuations point to elevated expectations for Boeing. If it does not meet those expectations, the stock could suffer and slowdown or even bring down the DOW.

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