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S&P 500 is more expensive than it looks

May 23, 2011 4:23 AM ETSPY
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Oil & Gas, Value

Seeking Alpha Analyst Since 2010

S&P 500 is currently trading at PE multiple of just over 15. Find below PE graph of S&P 500 since 1950. S&P 500 reached peak valuation of over 30 during the .com bubble in 2000. The lowest valuation since 1950 is around 7.5. Though current valuation of 15 for the index looks fair, a deeper look shows that certain sectors are trading at low multiples compared to history pulling down the average PE for the index.

The below bar chart plots top 50 sub indices of S&P 500 in terms of weights and their respective PE ratios.

Financials, Pharmaceuticals/Health Care and Large Cap Technology are cheaper compared to the Index
  • Financials (Banks and Insurance Companies) are trading at much cheaper PE multiple to the index. Average PE ratio (weighted by index weights) of all financial sub indices in S&P 500 is 12.45. Financials make up for about 12.38% of S&P 500.
  • Pharmaceuticals and health care related stocks are also trading at lower multiple to the index at 13.51. This block makes up about 10% of S&P 500 Index.
  • Technology is one sector which shows high divergence in valuations. While large cap software (like Oracle, Microsoft) and hardware companies’ (like HP, Dell) trade at multiples below index PE, Internet retailers and application software companies are the most expensive.
These 3 sectors almost make up 30% of S&P 500 index. PE ratio S&P 500 ex these 3 sectors is almost 18, which might not be that cheap.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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