S&P 500 Valuation Dashboard - May Edition

Summary

• A score in value and quality for every sector.
• Evolution since last month.
• The best and the worst sectors for these metrics.
• This idea was discussed in more depth with members of my private investing community, Quantitative Risk & Value. Get started today »

This monthly series gives fundamental scores by sector for companies in the S&P 500 index (VOO, SPY, IVV). I follow chosen fundamental factors for every sector and compare them to a historical baseline, so as to create a synthetic dashboard with a value score (V-score) and a quality score (Q-score). You can find here data that may be useful in a top-down approach.

Methodology

• The median value of 4 valuation ratios is calculated for S&P 500 companies in each sector: Price/Earnings (P/E), Forward Price Earning for the current year (Fwd P/E), Price to sales (P/S), Price to free cash flow (P/FCF).
• It is compared in percentage to its own historical average. For example, a difference of 10% means that the current median ratio is 10% over- or under-priced relative to its historical average in the sector.
• The V-score of a sector is the average of differences in percentage for the 4 factors, multiplied by -1. The higher is the better.
• The Q-score is the difference between the current median ROE (return on equity) and its historical average. The higher is the better.
• GICS sectors had major changes in 2016 (real estate) and in 2018 (communication). Historical averages have been calculated using the current sub-industry structure in the past when possible, so as to compare things that are comparable.

The choice of the valuation and quality ratios has been justified in previous articles. Among the simple, publicly available fundamental factors, they are the best predictors of future returns according to 17-year backtests. Median values are better reference data than averages for stock-picking. Each median is the middle point of a sector, which can be used to separate good and bad elements. A median is also less sensitive to outliers.

Sector valuation metrics on 5/3/2020

The next table reports the 4 valuation factors. There are 3 columns for each factor: the current median value, the historical average (“Avg”) between January 1999 and October 2015 taken as an arbitrary reference of fair valuation, and the difference in percentage (“%Hist”). The first column “V-score” shows the value score as defined above.

	V-score	P/E	Avg	%Hist	Fwd P/E	Avg	%Hist	P/S	Avg	%Hist	P/FCF	Avg	%Hist
All	-12.46	19.66	19.18	2.48	16.25	14.83	9.57	2.07	1.58	30.99	26.38	24.7	6.80
Cs. Discretionary	11.10	16.13	18.15	-11.12	14.60	14.11	3.47	0.90	1.01	-10.96	18.09	24.38	-25.81
Cs. Staples	-17.17	21.44	20.48	4.71	17.98	16.27	10.50	2.34	1.54	51.88	39.90	39.28	1.59
Energy	16.43	17.74	17.8	-0.36	17.72	14.38	23.22	0.74	1.94	-62.03	22.46	30.59	-26.57
Financials	18.61	9.75	15.02	-35.09	10.15	11.55	-12.08	1.56	1.89	-17.40	9.04	10.03	-9.87
Healthcare	-16.82	29.40	23.76	23.76	17.42	16.85	3.38	4.09	2.93	39.64	30.19	30.04	0.50
Industrials	-8.93	18.37	18.75	-2.05	15.93	14.52	9.70	1.61	1.24	30.17	25.12	25.66	-2.12
Technology	-14.90	26.60	28.14	-5.47	18.56	19.29	-3.77	4.40	2.84	55.05	28.57	25.11	13.80
Communication	12.86	15.18	21.28	-28.68	20.33	17.09	18.99	1.61	2.01	-19.75	20.52	26.31	-22.01
Materials	-2.64	17.89	19.74	-9.39	13.51	14.36	-5.93	1.48	1.15	28.63	26.77	27.53	-2.75
Utilities	-44.40	20.13	15.21	32.32	16.40	13.15	24.73	2.45	1.11	120.55	87.17	43.5	N/A
Real Estate	3.06	28.09	40.71	-30.99	41.80	36	16.11	7.53	6.67	12.85	46.50	51.8	-10.23

Click to enlarge

Energy: P/FCF Avg starts in 2000 - Utilities: P/FCF too volatile to be relevant - Real Estate: Avg start in 2006

V-score chart:

Sector quality metrics

The next table gives a score for each sector relative to its own historical average. Here, only one factor is accounted.

	Q-score (Diff)	Median ROE	Avg
All	-0.52	14.41	14.93
Cs. Discretionary	3.06	20.94	17.88
Cs. Staples	-3.84	20.22	24.06
Energy	-12.93	1.96	14.89
Financials	-1.43	11.10	12.53
Healthcare	0.05	17.65	17.6
Industrials	4.07	21.02	16.95
Technology	12.26	26.01	13.75
Communication	3.65	15.62	11.97
Materials	0.30	14.19	13.89
Utilities	-1.12	10.23	11.35
Real Estate	1.09	7.92	6.83

Click to enlarge

Q-score chart:

Momentum

The next table and chart show the return in 1 month and 1 year for all sectors, represented by their respective SPDR ETFs (including dividends).

sector	ETF	1-month return	1-year return
All	SPY	14.89%	-0.90%
Cs. Discretionary	XLY	19.79%	-4.02%
Cs. Staples	XLP	7.60%	3.93%
Energy	XLE	29.80%	-39.02%
Financials	XLF	12.84%	-18.80%
Healthcare	XLV	14.81%	11.97%
Industrials	XLI	10.51%	-17.80%
Technology	XLK	16.15%	15.56%
Communication	XLC	16.71%	0.91%
Materials	XLB	18.09%	-7.38%
Utilities	XLU	7.30%	-0.35%
Real Estate	XLRE	12.91%	-5.88%

Click to enlarge

Monthly Momentum:

Annual Momentum:

Interpretation

For median-based metrics, S&P 500 companies look overpriced by about 12.5%, with a note of caution: the impact of global lockdowns on ratio denominators is still unknown.

Since last month:

• The S&P 500 went up by 14.9%.
• The V-score has apparently deteriorated by about 17 percentage points (see the note of caution above). It has deteriorated in all sectors during April’s rally due to price action.
• The Q-score, which was already on a slow downtrend for a few months before the black swan hit the market, fell by 1 point. It has improved in healthcare, it is stable in consumer staples, energy, real estate, and deteriorated elsewhere.
• Energy was the best-performing sector in April after being the worst one in March.
• Looking at 1-year total returns, the broad index, communication and utilities are close to break-even. Technology, healthcare and consumer staples are the only 3 sectors showing significant gains. Energy is lagging with a loss of 39%.

According to these metrics, financials, energy, consumer discretionary and communication services are underpriced by 10% to 20%. In the current environment, among these 4 sectors the “underpriced” tag seems appropriate only for communication. Materials and real estate look close to fair price. Other sectors are overvalued by 9% to 17%, except utilities by more than 40%. Combining valuation and quality metrics, communication and technology are the safest sectors.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[JES]

What do you use for “E” and “S” in your forward PE and P/S calculations and where do you get these values?

[Fred Piard]

@JES Sales are TTM values (1 trailing year) from quarterly earnings, Forward PE is calculated with the mean EPS estimate of analysts for the next fiscal year. Ratios are made available by many screeners and websites including SA on the "value" tab on a stock's page. Ex: seekingalpha.com/...

[Fred Piard]

(continued) as explained in the article, I calculate median values by sector.