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 periods of high uncertainty is that a lot of analysts and talking heads on market media seem to forget that all trends are finite. That means that while pullbacks and corrections within long-term upward trends are normal, and generally healthy, at some point that trend will reverse downward. That often means that no matter how much hand-wringing you see among talking heads on market media, they’ll be as inevitably late to the game as 99% of average investors.
I think part of the reason even the most seemingly knowledgeable analysts miss the boat is that 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. Earlier this year, the market dropped more than -10% from its late-2021 high, prompting a lot of these talking heads to start calling for a new bear market. Given the way the market has reclaimed about 10% of its drop as of yesterday’s close, it’s safe to say those call were 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, properly channeled, it can be a good thing. It makes you 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 one of the three largest chemical producers on the planet. 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 $47.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 165% (not a typo), while revenues grew by a little more than 34%. In the last quarter, earnings were about -22% lower, while sales fell by about -3.2%. The company’s margin profile is stable, with Net Income that was 11.48% of Revenues over the last twelve months, and 12.09% in the last quarter.
Free Cash Flow: DOW’s free cash flow is healthy despite its decrease in the last quarter. It was $4.79 billion in the last quarter versus a little over $5.3 billion in the quarter prior. It does also mark a useful increase over the past year, when free cash flow was about $4.45 billion. The current number also translates to an attractive Free Cash Flow Yield of 10%.
Debt to Equity: DOW’s debt/equity ratio is high, at .76. 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 $3.5 billion two quarters prior) versus about $14.3 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 4.33% 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 $75 per share. That suggests that even with the stock’s recent bullish momentum, the stock remains undervalued by about 17% 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 downward trend from a high in May of last year at around $71.50 to its December low at around $52. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s pattern since the start of 2022 is a nice, upward sloping bullish trend, which is directly counter to the broad market’s trend over the same period of time. Since the beginning of March, the stock has bounced off support at around $58 to pick up momentum that has pushed the stock above the 61.8% retracement line at $64. Current support should be at $64, with expected immediate resistance at around $67.50. A drop be low $64 should find next support at around $62.
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. The stock also has picked up bullish momentum in building an intermediate-term upward trend, making it a rare winner in the market lately. If you prefer to work with short-term trading strategies, the stock’s recent push above $64 could be a signal to think about buying the stock or working with call options, with a useful price target at around $67.50. A drop below $64 would be a good signal to consider shorting the stock or buying put options, using $62 as a quick initial profit target on a bearish trade, or $59.45 if the stock’s bearish momentum accelerates.