Value Investors – This One’s For You

The only good thing about stock market corrections and/or bear markets is that they eventually create notable opportunities for outsized future returns.Consider:

  • Amazon was trading for $52 at the end of 2008. Friday’s close was $1,495.
  • Microsoft traded at $15 in early 2009. Friday’s close was $87.
  • And, of course, the S&P 500 bottomed intraday at 666 in March 2009. Friday’sclose was 2,588.

Now, we’re certainly nowhere near the cataclysmic lows of March 2009; the S&P 500 is only down 3.2% on the year and 9.9% off the all time highs. At the same time, it’s never too early to start doing the work on where to place fresh capital during the current turmoil.

Since the central complaint about US equities is valuation, we pulled the latest FactSet Earnings Insight report to assess sector-level price earnings ratios. As we have noted in prior reports, the S&P 500 looks expensive because of one group: Technology. But how does everything else fare?

Here are the five sectors that are cheaper than the S&P 500’s 16.4x valuation on the basis of forward PE multiple:

  • Telecomm: 10.3x this year’s expected earnings. This is notably cheaper than 5/10-year averages of 13.5x/14.1x, respectively.
  • Financials: 13.0x this year. That is inline with historical 5/10-year averages of 13.0x/12.5%, respectively.
  • Health Care: 15.3x this year. That’s cheaper than the 5-year average (16.0x) but dearer than the 10-year record (13.7x).
  • Utilities: 16.1x this year. This is inline with the 5 year mean at 16.3x, but richer than the 10-year average of 14.5x.
  • Materials: 16.1x this year. More expensive than either the 5-year average (16.1x) or the 10-year mean (14.9x).

The other 6 sectors of the S&P 500 (Tech, Consumer Staples/Discretionary, Industrials, Energy and Real Estate) are all more expensive than the index.The most notable group when it comes to its premium over historical valuations is, as noted, Technology. At 18.1x, it is 15% more highly valued that its 5-year average multiple and 25% above its 10-year average valuation.

Regular readers know where this is going: Financials look to have the best combination of reasonable valuations and fundamentals. These include:

  • Regulatory tailwinds. Can you name any sector other than Financials where government actually wants to reduce an industry’s constraints?
  • A strong capital base and good incremental profits. Wall Street analysts expect the Financials to post 27% earnings growth this year. That is almost double the 18% growth expected for the S&P 500 as a whole.
  • Less exposure to global tariff renegotiations than most sectors. The Financials sector of the S&P 500 generates 26% of its revenues from outside the US, less than the index average. Take out the money center banks, and that percentage goes even lower.

Now, if you layer on (eventual) higher long-term interest rates then the Financials story gets even better. But trading inline to historical valuation ranges, the Financials should do well enough even if rates don’t move materially higher.

Source: https://insight.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_032318A.pdf

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