Two S&P 500 sectors trade below economic book value after Q3’21 results

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This report is a free, abridged version of S&P 500 & Sectors: Price-to-Economic Book Value Through 3Q21, one of the reports in our quarterly series on market and sector fundamental trends.

The full version of this report analyzes[1][2] market capitalization, economic book value, and price-to-economic book value (PEBV) ratio for the S&P 500 and each of its sectors (latest quarter analysis is here).

The S&P 500’s trailing PEBV ratio fell year-over-year

The S&P 500 rolling PEBV ratio remains unchanged year-over-year at 1.5 in 3Q21. The S&P 500’s trailing PEBV ratio hovered around this level for much of 2017-19, before falling in early 2020.

This rolling PEBV ratio compares the S&P 500’s expected future earnings (incorporated in its equity valuation) to TTM earnings in 3Q21. At 1.5, the S&P 500 valuation implies that S&P 500 earnings (NOPAT) will rise 50% from 3Q21 levels.

Key details on selected S&P 500 sectors

Two S&P 500 sectors, telecommunications services and consumer staples, are trading below their economic book value and two, healthcare and financials, are trading at their economic book value. The telecommunications services sector has the lowest PEBV ratio among the 11 S&P 500 sectors based on 11/16/21 prices and 3Q21 10-Qs financial data.

A PEBV ratio of 0.5 means the market expects 3Q21 telecom services sector earnings to decline 50% from current levels. On the other hand, investors expect the real estate and energy sectors (PEBV ratios of 3.9 and 3.1) to improve earnings more than any other sector in the S&P 500.

Below, we highlight the telecommunications services sector, which has the lowest PEBV ratio of the S&P 500 sectors.

Example of sector analysis[3]: Telecom services : Trailing PEBV ratio = 0.5

Figure 1 shows that the mobile PEBV ratio for the telecommunications services sector fell from 0.8 in 3Q20 to 0.5 in 3Q21. The market capitalization of the telecommunications services sector fell from $758 billion in 3Q20 to $677 billion in 3Q21, while its economic book value fell from $997 billion in 3Q20 to $1.5 trillion in 3Q21.

Figure 1: PEBV ratio of telecommunications services: December 2004 – 11/16/21

Sources: New Constructs, LLC and company filings. The November 16, 2021 measurement period uses price data as of that date and incorporates 3Q21 10-Q financial data, as this is the earliest date for which all calendar 3Q21 10-Qs for components of the S&P 500 were available.

Figure 2 compares market capitalization and economic book value trends for the telecommunications services sector since 2004. We sum the individual S&P 500/sector values ​​for market capitalization and economic book value. We call this approach the “Aggregate” methodology, and it matches the S&P Global (SPGI) methodology for these calculations.

Figure 2: Market capitalization of telecommunications services and economic book value: December 2004 – 16/11/21

Sources: New Constructs, LLC and company filings. The November 16, 2021 measurement period uses price data as of that date and incorporates 3Q21 10-Q financial data, as this is the earliest date for which all calendar 3Q21 10-Qs for components of the S&P 500 were available.

The Aggregate Methodology provides a simple view of the entire S&P 500/sector, regardless of company size or index weighting, and is how S&P Global (SPGI) calculates metrics for the S&P500.

For additional perspective, we compare the aggregate method for the rolling PEBV ratio with two other market-weighted methodologies: market-weighted measures and market-weighted drivers. These market-weighted methodologies add more value to ratios that do not include market values, for example, ROIC and its drivers, but we nevertheless include them here 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 rolling PEBV ratio of the telecommunications services sector.

Figure 3: Comparison of PEBV ratio methodologies for telecommunications services: December 2004 – 11/16/21

Sources: New Constructs, LLC and company filings. The November 16, 2021 measurement period uses price data as of that date and incorporates 3Q21 10-Q financial data, as this is the earliest date for which all calendar 3Q21 10-Qs for components of the S&P 500 were available.

This article originally published on November 24, 2021.

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

Appendix: Trailing PEBV Ratio Analysis with Different Weighting Methodologies

We derive the above measures by summing the individual S&P 500/sector constituent values ​​for market capitalization and economic book value to calculate the PEBV ratio. We call this approach the “Aggregate” methodology.

The Aggregate Methodology provides a simple view of the entire S&P 500/sector, regardless of company size or index weighting, and is how S&P Global (SPGI) calculates metrics for the S&P500.

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

  1. Market-weighted measures – calculated by weighting according to market capitalization the PEBV ratio of individual companies relative to their sector or to the entire S&P 500 at 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. We multiply the PEBV ratio of each company by its weight
    3. The S&P 500/sector trailing PEBV is equal to the sum of the weighted trailing PEBV ratios for all S&P 500 companies/sector
  2. Market-weighted drivers – calculated by weighting the market capitalization and the economic book value of individual companies in each sector at 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. We multiply the market cap and economic book value of each company by its weight
    3. We add the weighted market capitalization and weighted economic book value of each S&P 500 company/sector to determine the S&P 500 or sector weighted FCF and weighted enterprise value.
    4. The rolling PEBV ratio of the S&P 500/sector is equal to the weighted market capitalization of the S&P 500/sector divided by the weighted economic book value of the S&P 500/sector

Each methodology has its pros and cons as listed below:

Aggregate method

Benefits:

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

The inconvenients:

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

Market-weighted measures method

Benefits:

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

The inconvenients:

  • Vulnerable to outlying results from a single company have a disproportionate impact on the overall PEBV ratio, as we will show below.

Market-weighted factor method

Benefits:

  • Considers a company’s market capitalization relative to the S&P 500/sector and weights its size and economic book value accordingly.
  • Mitigates the disproportionate impact of a company’s outlying results on overall results.

The inconvenients:

  • More sensitive to large swings in market capitalization or economic book value (which can be affected by changes in WACC) from period to period, especially from companies with a large weighting in the S&P 500 /Sector.

[1] We calculate these measurements based on S&P Global‘s (SPGI), which sums individual S&P 500 component values ​​for market capitalization and economic book value before using them to calculate metrics. This is what we call the “Aggregate” methodology.

[2] Our research is based on the latest audited financial data, which is 3Q21 10-Q in most cases. Price data is as of 11/16/21.

[3] The full version of this report provides analysis for each sector, like what we show for this sector.

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