These Undervalued Stocks Could Lead The Dow 30 Higher

The Dow Jones Industrial (DJI) Average closed at 14,253 Tuesday, surpassing its previous all time high of 14,164 in October 2007. The index jumped nearly 126 points or 0.9% during the day powered by China’s strong economic growth targets, a bump in European retail sales and a continued recovery in the US housing market.

A first look at Dow’s chart reveals that the index has been rising over the past four years recovering from its lows of the financial crisis of 2008-09. During this period not just the 30 stocks in the Dow but stocks across the markets rose on support from monetary easing by the Federal Reserve and other central banks around the world. However, more recently, concerns related to slowing economic growth in emerging economies, persistent high unemployment levels and the sovereign debt crisis in Europe were preventing stocks, including the Dow 30, from rising further.

Data released by statistics agency Eurostat showing a jump of 0.9% in retail sales in January (compared to a drop of 0.7% in December) for the European Union and China’s optimistic economic growth target of 7.5% for the current fiscal year allayed investor concerns and boosted markets Tuesday. ^[1] The shares of several Dow 30 companies including GE, Boeing, UTC, Intel, IBM, Microsoft, Home Depot, McDonald’s, Johnson & Johnson and UnitedHealth rose yesterday to take the index to its all-time high. Below we look at some of stocks that are undervalued according to our analysis which could fuel the Dow 30 to move even higher.

Can the Dow Jones Industrial Average rise even further?

We currently have an estimate of 14,421 for the Dow, approximately 1% above its current level. Our optimistic forecast is based on continued stimulus from the Fed (which till date is purchasing Treasury and mortgage-backed securities worth $85 billion per month to keep interest rates low) in the near term, China achieving its growth targets, and Europe not slipping into recession – all of which are likely. ^[2]

In the near term, uncertainty surrounding Italian election results and their impact on the Euro crisis, and sequestration negotiations in Washington may provide some downside to the Dow. But the long-term fundamentals support an upside.

See our complete analysis of each stock on the Dow 30 here

1) Technology: Among the Dow 30 companies belonging to the technology sector, we are bullish on IBM (NYSE:IBM), Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT).

IBM will benefit from its new services in cloud computing, big data analytics and mobile. According to IDC, worldwide IT spending is set to rise 5.7% year-over-year to over $2.1 trillion in 2013, and approximately 90% of growth in the IT market from 2013 through 2020 will occur in cloud/mobile/social/big data – the areas in which IBM is focusing. The company will also benefit from its focus on emerging markets where more than 50% growth in IT spending is expected to take place. ^[3]

We anticipate Intel to benefit from its leadership position in the PC segment as demand for PCs improves especially from emerging markets over the coming years. Additionally, Intel’s entry into the mobile computing space holds strong promise. Microsoft’s sales and profits will likely rise on greater adoption of Windows 8 and entry into the tablet and smartphone markets.

2) Industrials: Our price estimates for the five industrial stocks – GE, United Technologies, Caterpillar, Boeing and 3M – on the Dow 30 are either approximately in line or above their current market prices. We feel Boeing (NYSE:BA) and Caterpillar (NYSE:CAT) in particular have potential upsides to their current market prices.

Boeing, despite the grounding of its 787 Dreamliners by the Federal Aviation Administration (FAA), is poised for growth over the coming years driven by an increase in global market size for commercial airplanes. The company currently forecasts worldwide demand for 34,000 commercial airplanes worth $4.5 trillion over the next 20 years. ^[4] With 40% market share, Boeing’s growth from commercial aviation will more than offset the decline in its defense business from lower U.S. defense spending.

For Caterpillar, the long-term sales growth in mining, construction and power-related businesses will be driven by rising global demand for energy and increasing prosperity and urbanization in emerging economies. Current concerns related to the company’s slowing production will also be addressed as demand improves with economic growth in key markets like China.

3) Telecom Hardware: Here, we expect large upside for Cisco (NASDAQ:CSCO). Having done relatively well in an uncertain macro-environment, we expect Cisco to benefit from its dominant market position and restructuring initiatives as network infrastructure spending recovers. Driven by the key trends of mobility and cloud computing, data demand is continuing to grow unfettered despite the ongoing macroeconomic concerns. This means that enterprises and service providers will need to spend on network upgrades eventually, increasing the demand for Cisco’s products and services in the long run. Additionally, as a result of restructuring, the company has regained focus on its core networking products which we expect will help it capture more value from the ongoing trends. (see Cisco’s Earnings Were Solid Despite Macro Challenges)

4) Healthcare: In this sector, we have a significant upside for UnitedHealth (NYSE:UNH). We are optimistic about growth in the company’s health insurance business due to the addition of around 30 million Americans to the health insurance market through Obamacare and a rise (with economic growth) in the number of employer-sponsored health coverage plans. Entry into the fast-growing Brazilian health insurance market will aid growth provided by the expanding health insurance market in the U.S.

Merck (NYSE:MRK), another Dow 30 company, might also see an upside. Beginning 2014, we anticipate Merck’s sales and profits to rise on the strength of its pipeline drugs like Suvorexant and Odanacatib and continued growth in sales of its approved drugs like Januvia, Janumet, Isentress and Gardasil.

We have upsides for a few more Dow 30 stocks, including AT&T (NYSE:T), Bank of America (NYSE:BAC), Chevron (NYSE:CVX), Exxon Mobil (NYSE:XOM) and Wal-Mart (NYSE:WMT).

Understand How a Company’s Products Impact its Stock Price at Trefis

1. European retail sales up sharply in January, March 5 2013, www.eubusiness.com [↩]
2. Dow closes at an all time high: what you need to know, March 5 2013, finance.yahoo.com [↩]
3. IDC Predicts 2013 Will Be Dominated by Mobile and Cloud Developments as the IT Industry Shifts Into Full-Blown Competition on the 3rd Platform, November 29 2012, www.idc.com [↩]
4. Long-term commercial aviation market forecast, March 6 2013, www.boeing.com [↩]