February 18, 2002; McDep Ratio Hinted at Power Stock Collapse

Nine months after our first application of the McDep Ratio to power stocks we find that the valuation has worked surprisingly well.  That thought was discussed in our recent Stock Idea changing the rating on American Electric Power to Neutral from Buy.  Here we present the results in a way that makes the point more dramatically (see Chart).  The correlation of high McDep Ratio with subsequent stock price change is almost perfect.  In fact it is better in this case than in any we can recall.

To be more sophisticated we should display unlevered appreciation/depreciation because the McDep Ratio is a measure of unlevered valuation.  The refinement seems hardly worth the effort in this case, but it might help explain why lower-debt DUK deviates slightly from the pattern. 

Is this all just academic hindsight?  There may be some, but we did have an official sell recommendation on the second stock from the left.  More important is the question for the future.  Are today's high McDep Ratio stocks anywhere near as vulnerable as the power stocks proved to be?