Two S&P 500 Sectors Trade Below Economic Book Value After 2Q21 Results

This report is an abridged version of S&P 500 & Sectors: Price-to-Economic Book Value Through 2Q21, one of the reports in my quarterly series on Fundamental Market and Industry Trends.

The report analyzes[1] Market capitalization, economic book value and price to economic book value (PEBV) for the S&P 500 and each of its sectors (last quarter analysis is here). My company’s research is based on the latest audited financial data, which is 2Q21 10-Q for most companies. Price data is as of 08/18/21.

These reports harness fundamental data that overcomes loopholes in legacy fundamental data sets. Investors armed with the Core Earnings data stream benefit from idiosyncratic alpha.

S&P 500 leakage PEBV ratio increased year over year

The trailing PEBV ratio for the S&P 500 fell from 1.4 in 2Q20 to 1.5 on 8/18/21, when all companies in the S&P 500 provided quarterly data for 2Q21. The S&P 500 trailing PEBV ratio was close to this level for much of 2017-2019, before dropping significantly in early 2020. This trailing PEBV ratio compares the expected future earnings of the S&P 500 (incorporated into its equity valuation) to the benefits of TTM in 2Q21. At 1.5, the S&P 500 valuation implies that S&P 500 earnings (NOPAT) will rise 50% from 2Q21 levels.

Key details on some sectors of the S&P 500

Two sectors of the S&P 500, Telecommunications Services and Consumer Staples, are trading below their economic book values. The telecommunications services sector has the lowest PEBV ratio among the 11 sectors of the S&P 500 based on prices as of 8/18/21 and financial data for 2Q21 10-Qs.

A PEBV ratio of 0.5 means the market expects 2Q21 telecom services sector profits to decline 50% from current levels. On the flip side, investors expect the Energy and Real Estate sectors (PEBV ratios of 17.6 and 3.6) to improve their earnings more than any other sector in the S&P 500. Ci Below, I highlight the telecommunications services sector, which has the lowest PEBV ratio of the S&P 500 sectors.

Example of sector analysis[2]: Telecommunications services: Follower PEBV ratio = 0.5

Figure 1 shows that the PEBV ratio for the telecommunications services sector fell from 0.8 in 2Q20 to 0.5 in 2Q21. The market capitalization of the telecommunications services industry grew from $ 730 billion in 2Q20 to $ 760 billion in 2Q21, while its economic book value increased from $ 957 billion in 2Q20 to $ 1.4 trillion in 2Q21 .

Figure 1: PEBV leakage ratio of telecommunications services: December 2004 – 08/18/21

The measurement period of August 18, 2021 uses the price data on that date and incorporates financial data from the 10-Qs of 2Q21, as this is the earliest date for which all 10-Qs of 2Q21 for components of the S&P 500 were available.

Figure 2 compares the trends in market capitalization and economic book value for the telecommunications service industry since 2004. I am summing the individual constituent values ​​of the S&P 500 / sector for market capitalization and economic book value. I call this approach the “Aggregate” methodology, and it corresponds to the S&P Global (SPGI) methodology for these calculations.

Figure 2: Market capitalization of telecommunications services and economic book value: December 2004 – 08/18/21

The measurement period of August 18, 2021 uses the price data on that date and incorporates financial data from the 10-Qs of 2Q21, as this is the earliest date for which all 10-Qs of 2Q21 for components of the S&P 500 were available.

The Aggregate methodology provides a direct snapshot of the entire S&P 500 / sector, regardless of company size or index weight, and is how S&P Global (SPGI) calculates metrics for the S&P 500.

For an additional perspective, I compare the aggregate method for the tracking PEBV ratio with two other market-weighted methodologies: market-weighted metrics and market-weighted drivers. These market weighted methodologies add more value for ratios that do not include market values, for example ROIC and its drivers, but I am including them here, nonetheless, for comparison purposes. Each method has its advantages and disadvantages, which are detailed in the appendix.

Figure 3 compares these three methods of calculating the following PEBV ratio for the telecom services sector.

Figure 3: Comparative PEBV Leakage Reporting Methodologies: December 2004 – 08/18/21

The measurement period of August 18, 2021 uses the price data on that date and incorporates financial data from the 10-Qs of 2Q21, as this is the earliest date for which all 10-Qs of 2Q21 for components of the S&P 500 were available.

Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation for writing about a specific action, style, or theme.

Annex: Analyze the tracking PEBV ratio with different weighting methodologies

I derive the above metrics by adding the individual values ​​of the S&P 500 constituents / sector for market capitalization and economic book value to calculate the PEBV leakage ratio. I call this approach the “Aggregate” methodology.

The Aggregate methodology provides a direct snapshot of the entire S&P 500 / sector, regardless of company size or index weight, and is how S&P Global (SPGI) calculates metrics for the S&P 500.

For an additional perspective, I compare the aggregate method for the trailing PEBV ratio with two other market-weighted methodologies. These market weighted methodologies add more value for ratios that do not include market values, for example ROIC and its drivers, but I am including them here, nonetheless, for comparison:

Market-weighted metrics – calculated by weighting by market capitalization the trailing PEBV ratio for individual companies against their sector or the overall S&P 500 during each period. Details:

  1. The weight of the company is equal to the market capitalization of the company divided by the market capitalization of the S&P 500 or its sector
  2. I multiply the follower PEBV ratio of each company by its weight
  3. S&P 500 / Sector trailing PEBV is equal to the sum of the weighted ratios of PEBV trailing for all companies in the S&P 500 / sector

Market weighted factors – calculated by weighting the market capitalization and the economic book value of the individual companies in each sector during each period. Details:

  1. The weight of the company is equal to the market capitalization of the company divided by the market capitalization of the S&P 500 or its sector
  2. I multiply the market capitalization and the economic book value of each company by its weight
  3. I sum the weighted market capitalization and the weighted economic book value for each company in the S&P 500 / each sector to determine the S&P 500 or the weighted FCF of the sector and the weighted enterprise value
  4. The S&P 500 trailing PEBV / sector ratio is equal to the weighted S&P 500 / market capitalization of the sector divided by the weighted economic book value of the S&P 500 / sector

Each methodology has its advantages and disadvantages, as shown below:

Aggregate method

Advantages:

  • A direct overview of the entire S&P 500 / sector, regardless of company size or weight in indices.
  • Corresponds to how S&P Global calculates metrics for the S&P 500.

The inconvenients:

  • Vulnerable to the impact of companies entering / exiting the group of companies, which could unduly affect overall values. Also sensitive to outliers over a period of time.

Market-weighted metrics method

Advantages:

  • Takes into account a company’s market capitalization relative to the S&P 500 / sector and weights its metrics accordingly.

The inconvenients:

  • Vulnerable to outliers from a single company disproportionately impacting the overall PEBV leakage ratio, as I will show below.

Market Weighted Drivers Method

Advantages:

  • Takes into account a company’s market capitalization relative to the S&P 500 / sector and weights its size and economic book value accordingly.
  • Mitigate the disproportionate impact of a company’s aberrant results on overall results.

The inconvenients:

  • More sensitive to large fluctuations in market capitalization or economic book value (which may be affected by changes in the WACC) from period to period, especially companies with a heavy weight in the S&P 500 / sector.

[1] I calculate these metrics based on the S&P Global (SPGI) methodology, which sums up the individual S&P 500 constituent values ​​for market capitalization and economic book value before using them to calculate the metrics. This is what I call the “Aggregate” methodology. Get more details in Appendices I and II. [2] The full version of this report provides analysis for each industry like what I am showing for that industry.


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