One of the things that market uncertainty does to a lot of investors is to make them more hesitant about taking on new positions. I think that’s a pretty natural reaction, especially when we see the market start to reverse existing trends. Since the beginning of the year, increasing bearish sentiment has finally pushed all three major indices into legitimate correction territory.
Being hesitant, and even uncertain about whether you should be looking for new investments can be either a good thing, or a bad thing depending on how extreme your reaction, or fear of risk is. One of the things I have learned to find a little frustrating about these periods where the market has staged a correction of a longer upward trend is that a lot of analysts and talking heads on market media seem to forget that corrections are a natural and necessary part of long-term market dynamics. They automatically start talking about the potential or likelihood for the next scary potential event – a bear market along with an economic recession, but they ignore the fact that most corrections never extend into actual bear market conditions.
They also tend to ignore the actual distinction between a correction and a bear market. A legitimate correction starts when a stock or the market has dropped at least -10% off of its last high point – but most technicians won’t actually start using the term “bear market” until, and unless the market then extends that corrective drop at least -10% more. I’ve already seen some analysts saying that a new bear market is starting, but that is clearly premature.
The biggest problem with this mischaracterization of market conditions is the way that it tends to paralyze average investors. It’s natural to be hesitant and uncertain, and I think that is a good thing because it makes us think a little more critically about the potential risk you may be taking with any investment. It doesn’t mean, however, that there aren’t still useful opportunities to be had in the marketplace. There are always sectors and industries that are likely to diverge from the market, even when other sectors and industries are going down.
One of the sectors of the market that I have learned to pay a lot of attention to over the years is the Materials sector. This sector is made up of industries, and companies that transform raw materials and chemicals into components and goods that other industries use to create and produce the finished products that businesses and consumers use. That doesn’t necessarily make them immune from economic cycles and downturns, but it does mean that many of these companies produce goods that are needed and continue to see demand even during difficult economic times. Their exposure to the variability of costs in raw materials and commodities also forces most of them to consider ways they can minimize and manage those variances on a long-term basis. I think the intelligence many of these management teams have about how to run their business also means that there are useful opportunities that can be found in this sector if you’re willing to take the time to dig into them.
That brings me to today’s highlight. Dow Inc. (DOW) is a stock that has only been traded publicly since early 2019, but is also a company with a long history behind it. Spun off into its own public entity from DowDupont, its primary subsidiary, Dow Chemical, is on of the three largest chemical producers in the entire world. When DOW was spun off of DowDupont, the new company was immediately added to the Dow Jones Industrial Average. Even with the difficulties that have been associated with the conditions of the past two years, this is a company that has leveraged its position as a market leader and economies of scale to manage raw materials cost risks that many expect to extend through this year. They also boast healthy free cash flow, stable operating margins, a generally solid balance sheet, and a very attractive dividend. Are all of these elements together enough to suggest the stock could also offer a useful, value-based opportunity? Let find out!
Fundamental and Value Profile
Dow Inc. is a holding company for The Dow Chemical Company and its subsidiaries (TDCC). The Company’s portfolio of plastics, industrial intermediates, coatings and silicones businesses delivers a range of science-based products and solutions for its customers in various market segments, such as packaging, infrastructure, mobility and consumer care. The Company’s portfolio is comprised of six global business units, which are organized into three operating segments: Packaging & Specialty Plastics, Industrial Intermediates & Infrastructure and Performance Materials & Coatings. Packaging & Specialty Plastics consists of two global businesses: Hydrocarbons & Energy and Packaging and Specialty Plastics. Industrial Intermediates & Infrastructure consists of two customer-centric businesses: Industrial Solutions and Polyurethanes & Construction Chemicals. Performance Materials & Coatings includes two global businesses: Coatings & Performance Monomers and Consumer Solutions. DOW has a current market cap of about $26.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 450% (not a typo), while revenues grew by about 52.8%. In the last quarter, earnings were 1.10% higher, while sales grew by about 6.9%. The company’s margin profile is stable, with Net Income that was 11.33% of Revenues over the last twelve months, and 11.34% in the last quarter.
Free Cash Flow: DOW’s free cash flow is healthy despite its decrease in the last year. It was $5.3 billion in the last quarter versus almost $5.9 billion a year ago. It does also mark a useful increase from the quarter prior, when free cash flow was about $4.8 billion. The current number also translates to an attractive Free Cash Flow Yield of 12.69%.
Debt to Equity: DOW’s debt/equity ratio is high, at .82. This is generally a low number that indicates management takes a conservative approach to leverage. Their balance sheet shows $2.9 billion in cash and liquid asset (down from $4.3 billion two quarters prior) versus about $14 billion in long-term debt. The decline in cash can be attributed, at least in part to the effect of the rising costs of raw materials (also called feedstocks), and which does continue to be a risk element in the quarters ahead.
Dividend: DOW’s annual divided is $2.80 per share, which translates to a yield of 4.95% at the stock’s current price. It is worth noting that the company’s dividend has been consistent at this level since its spinoff from DowDupont, and did not change in 2020 when many companies throughout the marketplace were slashing or eliminating their dividends altogether.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to worth with a combination of Price/Book and Price/Cash Flow analysis. The fact that this company has existed as a publicly traded entity for less than three years provides a limited historical sample to work with, so I have also incorporated the company’s PEG ratio, which adds estimates for the company’s future growth to the mix. All together, these measurements provide a long-term target at about $71.50 per share. That suggests that despite the stock’s recent bearish momentum, the stock is undervalued by about 29% from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s upward surge in the first part of 2021, from a low at around $51 in February of 2021 to its May peak at around $71.50. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that peak, the stock slid into a clear downward trend that bottomed in December at around $52, a little above the stock’s 52-week low. After rebounding strongly through December and into the middle part of January, the stock peaked at around $61 and has followed broad market momentum downward over the last few days. Current support is around $55, with immediate resistance at around $56. A push above $56 has limited immediate upside, with next resistance likely to be seen at around $57.50. A drop below $55 could see about $2 of near-term downside, with next support likely to be between $53, with the stock’s 52-week low around $51 in sight if bearish momentum continues to accelerate.
Near-term Keys: I think DOW’s fundamental profile in the face of the past two year’s pandemic-induced economic conditions is a very interesting story, with a very useful value proposition to boot. Given the current state of market momentum, I think that it’s probably smart to wait for now to see if the stock continues to drop further or finds a useful stabilization level to start moving back up again before taking on a new position. If you prefer to work with short-term trading strategies and don’t mind being aggressive, a push above $56 could be a signal to think about buying the stock or working with call options, so long as you set a very quick price target at around $57.50. A drop below $55 would be a good signal to consider shorting the stock or buying put options, using $53 as a solid initial profit target on a bearish trade, or $51 if the stock’s current momentum remains consistent.