Investing

2018 Outlook: How Exxon, GE, IBM, Merck and Disney Could Be the Top Dow Stocks

Jon C. Ogg

Published: December 7, 2017 7:35 am

Last Updated: January 12, 2020 5:41 am

It’s a raging bull market, and the Dow Jones Industrial Average has enjoyed incredible gains in 2017. As 2018 gets ever closer, investors have to decide how they will invest their money in the new year. The Dow is up about 22% year to date and up about 25% over the past year, and the indexes have all rallied more than 200% from the Great Recession’s bottom, which is now nearing nine years ago.

Even this raging bull market has left many well-known companies behind. Some key Dow stocks have quite simply been major disappointments, and some of them for more than a year. That makes them raging duds. The question is whether the past will mirror the future. It turns out that some down and out stocks don’t always stay down, and sometimes great turnarounds and recoveries can create huge victories for opportunistic and visionary investors.

24/7 Wall St. has been reviewing and creating initial forecasts for 2018. It turns out that it’s very hard to find well-known Wall Street strategists who currently think that the stock market is set for a big fall in 2018. S&P is calling for corporate earnings to keep growing, and most ratings agencies and international governmental agencies are now calling for global growth to pick up in 2018. Of course anything is possible, and we have to consider that there will be midterm congressional elections late in 2018.

Be advised that these are not to be considered formal forecast or formal predictions for 2018. We still have to get through December before making formal 2018 forecasts. These should be considered guides to what would set the stage for these Dow laggards to begin rewarding shareholders again.

Another consideration for investors is the reminder that the Dow’s price-weighted calculation makes it quite different compared with the S&P 500 and other indexes. Low-priced stocks just cannot swing the Dow, and that means that high-priced stocks would have to rise to help the Dow in 2018.

There are also many issues to consider about the Dow at the end of 2017. Here are some factoids about the Dow so far in 2017:

• Only four stocks (GE, Exxon, IBM and Merck) have seen their shares give negative returns so far in 2017.
• There are 11 Dow stocks up over 30% so far this year.
• The median gain in the Dow was 19%.
• The Dow’s 30 components have a combined market cap of roughly $6.7 trillion.
• The median Dow dividend is 2.18%, and nine Dow stocks yield 3% or higher.

As of the start of December, the top five gainers were more than impressive so far in 2017. Boeing was up about 75%, Caterpillar was up 51%, Apple was up 46%, McDonald’s was up 42% and Walmart was up 41%. After performance like that, it gets hard to keep them as the expected biggest Dow winners ahead.

Investors should at least take into consideration that Wall Street forecasting has been muted compared to the real world gains that have been seen. At the start of 2017, the Dow was already cheering after double-digit gains in 2016. And the target of 21,422 in 2017 seemed aggressive for more than an 8% gain. And even in late October it looked like a shoo-in for DJIA 25,000 in 2018. That felt bold then, but now it might feel muted now that the Dow crossed 24,000. Now we have the S&P 500 valued at just over 20 times expected 2017 normalized earnings and valued at roughly 19 times expected 2018 normalized earnings.

Here is the path that could allow the lagging stocks of Exxon Mobil, General Electric, IBM, Merck and Walt Disney to be among the top performing Dow stocks of 2018.

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Exxon Mobil: Could it finally give investors some gas?

Exxon Mobil Corp. (NYSE: XOM) has been a serious Dow laggard in 2017. Trading at $82.50, it has a consensus analyst target price of just $84.68. Exxon’s 3.7% dividend would imply a total return for the coming year of about 6% after factoring in dividends.

What if there is more to the story here, with Exxon’s value being $350 billion. What has been a serious non-contributor to Exxon shares for several years is its old $31 billion acquisition of XTO Energy. This gave Exxon a deep footing into natural gas, and natural gas development has been coming back after years of stagnation.

Natural gas production is now forecast to continue growing in the United States in 2018, led by strong export demand and utilities. This XTO’s non-event valuation in the old acquisition price versus the current market cap is now almost 10% of its total value, and this piece of the business could become a contributor to higher analyst valuations ahead.

Also worth noting is that Exxon is set to merge its refining and marketing companies into ExxonMobil Fuels & Lubricants Company, a move planned for the first quarter of 2018. Barclays recently kept its price target on Exxon north of $90, and the street-high analyst target is $100.

Exxon Mobil shares have a 52-week trading range of $76.05 to $93.22, and the company has a market cap of $349.2 billion.

Dear John: Is it General Electric or General Eclectic?

General Electric Co. (NYSE: GE) has been battered and bruised, and the departure of CEO Jeff Immelt and the replacement with John Flannery has so far been a “show me” story. The stock is down 40% so far in 2017, but with shares at $17.70, the consensus analyst price target of $22.64 implies upside of about 28%. This is the smallest Dow component due to its tiny price, so a recovering GE would not alone be enough to swing the Dow up without it indirectly pushing up other industrials.

Investors need to understand that GE analysts are likely to lower their price targets even further toward and after the start of 2018. Cutting the dividend was painful enough, but GE has become incredibly hard to run in its current state. What would change the bias on GE is if Flannery and his new chiefs actually deliver on the proposed changes. Unrelated or lagging business sales would be viewed positively.

GE could signal in 2018 that it would like to eventually exit its position in Baker Hughes as a subsidiary. And the company could continue trimming non-revenue employee segments. What if GE’s new leaner structure is able to be communicated more cleanly to the investing community? It’s no shoo-in that GE will do well in 2017, not at all, but even the hint of a recovery for later in 2018 or in early 2019 would probably create excitement. And what if GE announces a review for a breakup?

GE has a 52-week range of $17.46 to $32.38, and it has a market cap of $153.0 billion.

IBM: Please, let new leadership and growth initiatives take charge!

International Business Machines Corp. (NYSE: IBM) has become a serial disappointment, and the share price drop of 6% in 2017 is just another continued disappointment. At $154.50 a share, IBM has a consensus price target of $163.74, and the 3.9% dividend yield implies a total return scenario of about 9.5%.

IBM has underperformed for so long that sentiment remains incredibly negative, and analysts expect total revenues to remain flat from 2016 out to 2019. IBM’s growth initiatives are just finally starting to catch up to the declining IT-services operation. What if efforts behind Watson, artificial intelligence, blockchain and the cloud all see stronger growth and begin to impress investors and analysts more than they do today?

Merrill Lynch went way out on a limb with a $200 price target at the end of October. What if someone is finally right this time on being bullish about IBM? One more issue is that CEO Ginni Rometty has to be very close to being forced out of her job, and based on other CEO departures, we would expect IBM shares to pop higher if she were ousted. IBM was a $200 a share stock back in 2012, and it is valued at only 11 times expected 2018 earnings.

IBM has traded between $139.13 and $182.79 a share in the past year. It has a market cap of $143.2 billion.

Merck: Can it reverse its recent losses?

Merck & Co. Inc. (NYSE: MRK) also has been a disappointing Dow stock in 2017, with its total return down about 5%. Analysts have a very low growth target on earnings and revenues in 2018. But at $54.50 a share, after a handy sell-off from earlier highs this year, Merck’s consensus analyst target of $65.36 implies upside of 20%. That would be a total return of more than 23%, if you include the 3.4% dividend yield.

The big downward driver for Merck in 2017 has been this huge disappointment in Keytruda being withdrawn as a lung cancer drug filing for patients in the European Union. Merrill Lynch has remained quite bullish here, and Merck also recently committed to a $10 billion stock buyback plan that could keep a floor under Merck if shares were to remain under their highs.

Merck could also pleasantly surprise the markets with more investments in biotech or by acquiring more future support via buying companies with promising new pipelines. Merck is valued at only about 13.5 times next year’s consensus earnings from operations.

The stock has a 52-week trading range of $53.63 to $66.80, and Merck has a market cap of $147.9 billion.

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Walt Disney: Media deals versus Death Stars

Walt Disney Co. (NYSE: DIS) has endured a very strange couple of years. The consensus target price of $109.58 is only about 3% higher than the $105.90 current share price. What is interesting here is that Disney’s 52-week high of $116.10 is another 6% higher than the consensus target, and Disney shares peaked at $120 back in mid-2015.

The gains from Star Wars and Pixar have long been factored in, and more Star Wars installments will only grow, with a new trilogy and character-specific films. Investors have continued to remain more than concerned about the continued customer departures of ESPN subscribers. And now Disney may get deeper into networks with multi-billion-dollar acquisitions of certain 21st Century Fox assets. What if 2018 becomes the pivot point?

With a large stake in Hulu, Disney is going to spit its over-the-top cord-cutter service by launching its own platform and eventually exiting Netflix. Parents have no choice but to subscribe to the Disney service, and parents also know that there seems to be inelastic demand for Disney’s theme park tickets. The 1.5% yield likely will be heading up again in 2018.

RBC Capital Markets has a stronger view with a $125 price target. Without considering any merger gains (or subtractions) on operating earnings, Disney is valued at about 17 times next year’s consensus earnings expectations.

Walt Disney shares have changed hands between $96.20 and $116.10 in the past 52 weeks, and the market cap is $160.3 billion.

Please note that consensus analyst price targets and forward valuations were based on snapshot data from Thomson Reuters.