Three sectors of the all-cap index are trading below economic book value after 3Q21

This report is a free, abridged version of All Cap Index & Sectors: Price to Economic Book Value Through 3Q21, one of my quarterly series on fundamental market and sector trends.

Key points:

  • The back PEBV ratio for the NC 2000[1]my company’s all-cap index, fell from 1.7 in 3Q20 to 1.5 in 3Q21, implying constituent earnings will rise 50% from long-term 3Q21 levels.
  • Investors are the most pessimistic about the outlook for the telecom services sector, where stocks are priced for a 50% drop in earnings from 3Q21 over the long term.
  • The full version of this report analyzes[2],[3] market capitalization, economic book value and price-to-economic book value (PEBV) ratio for NC 2000 and each of its sectors.

The NC 2000 trailing PEBV ratio fell in 3Q21

The trailing PEBV ratio for the NC 2000 fell from 1.7 in 3Q20 to 1.5 in 3Q21. This advanced PEBV ratio compares the expected future earnings of the NC 2000 (incorporated in its equity valuation) to the TTM earnings in 3Q21. At 1.5, the NC 2000 valuation implies NC 2000 stock earnings will rise 50% from 3Q21 levels.

Key details on certain CN 2000 sectors

Among the NC 2000 sectors, telecommunications services, consumer staples and financials are trading below their economic book value and basic materials are trading at their economic book value. The Telecommunications Services sector has the lowest PEBV ratio among the eleven sectors in the All Cap Index based on 11/16/21 prices and 3Q21 10-Qs financial data.

A PEBV ratio of 0.5 means investors expect 3Q21 telecom services sector earnings to decline by 50%. On the other hand, investors expect the real estate sector (PEBV ratio of 3.4) to improve its earnings more than any other sector in the All Cap index.

Below I highlight the health sector.

Example of sector analysis[4]: Health: Lagging PEBV ratio = 1.2

Figure 1 shows that the mobile PEBV ratio for the healthcare sector fell from 1.5 in 3Q20 to 1.2 in 3Q21. The market capitalization of the healthcare sector fell from $5.1 trillion in 3Q20 to $6 trillion in 3Q21, while its economic book value fell from $3.4 trillion in 3Q20 to $5 trillion in 3T21.

Figure 1: PEBV Ratio of Health Care Monitoring: December 1998 – 11/16/21

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 3Q21 10-Qs for NC 2000 constituents were available.

Figure 2 compares market capitalization and economic book value trends for the healthcare sector since 1998. I summarize the individual NC 2000/sector values ​​for market capitalization and economic book value. I call this approach the “global” methodology, and it matches the S&P Global (SPGI) methodology for these calculations.

Figure 2: Healthcare Market Capitalization and Economic Book Value: December 1998 – 11/16/21

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 3Q21 10-Qs for NC 2000 constituents were available.

The Aggregate methodology provides a simple view of the entire NC 2000/sector, regardless of company size or index weighting, and is the way S&P Global (SPGI) calculates metrics for the S&P500.

For 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 to ratios that don’t include market values, eg ROIC and its drivers, but I’m including them here for comparison purposes nonetheless. Each method has its advantages and disadvantages, which are detailed in the appendix.

Figure 3 compares these three methods of calculating rolling PEBV ratios for the Healthcare sector.

Figure 3: PEBV end-of-care ratio methodologies compared: December 1998 – 11/16/21

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 3Q21 10-Qs for NC 2000 constituents were available.

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

I derive the above metrics by adding the individual constituent NC 2000/sector values ​​for market capitalization and economic book value to calculate the trailing PEBV ratio. I call this approach the “Aggregate” methodology.

The Aggregate methodology provides a simple view of the entire NC 2000/sector, regardless of company size or index weighting, and is the way S&P Global (SPGI) calculates metrics for the S&P500.

For 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 don’t include market values, e.g. ROIC and its drivers, but I’m including them here nonetheless, for comparison:

Market-weighted measures – calculated by weighting according to market capitalization the PEBV ratio of individual companies in relation to their sector or the overall NC 2000 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 NC 2000 or its sector
  2. I multiply the PEBV ratio of each company by its weight
  3. The rolling PEBV ratio NC 2000/Sector is equal to the sum of the rolling PEBV ratios weighted for all the companies of the NC 2000/sector

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 NC 2000 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 of each company in the NC 2000/each sector to determine the weighted market capitalization of the NC 2000 or the sector and the weighted economic book value
  4. The NC 2000/sector rolling PEBV ratio is equal to the NC 2000/sector weighted market capitalization divided by the NC 2000/sector weighted economic book value

Each methodology has its pros and cons as listed below:

Aggregate method

Benefits:

  • A direct look at the entire NC 2000/sector, whatever the size or weight of the company.
  • 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:

  • Takes into account a company’s market capitalization relative to the NC 2000 sector and weights its measures accordingly.

The inconvenients:

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

Market-weighted factor method

Benefits:

  • Considers a company’s market capitalization relative to the NC 2000 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 NC 2000 /Sector.

[1] The NC 2000 consists of the 2000 largest US companies by market capitalization in my company coverage. The components are updated on a quarterly basis (March 31, June 30, September 30 and December 31). I exclude companies reporting under IFRS and non-US ADR companies.

[2] I calculate these metrics based on S&P Global(SPGI), which sums the individual NC 2000 constituent values ​​for market capitalization and economic book value before using them to calculate the measures. This is what I call the “aggregate” methodology.

[3] My company’s 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.

[4] The full version of this report provides analysis for each sector like what I show for this sector.

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