Economic price-to-book ratio looks cheap based on 2021 earnings

This report[1],[2] is an abbreviated version of S&P 500 & Sectors: Price-to-Economic Book Value Looks Cheap Based on 2021 Profits.

S&P 500 trailing PEBV ratio fell to 2016 levels in 2021

Earnings rose faster than stock prices as the S&P 500 price-to-economic book value (PEBV) ratio fell to its lowest level since June 30, 2016, excluding pandemic levels. Specifically, the S&P 500 trailing PEBV ratio fell from 1.6 on 3/31/21 to 1.3 on 3/11/22.

This rolling PEBV ratio compares the expected future earnings of the S&P 500 (as reflected in its price) to its economic book value as of 11/3/22. At 1.3, the S&P 500 valuation implies that S&P 500 earnings (NOPAT) will rise 30% from 2021 levels.

Key details on selected S&P 500 sectors

Four S&P 500 sectors, Telecommunications Services, Consumer Staples, Healthcare and Financials, are trading below their economic book value and two, Basic Materials and Energy, 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 prices as of 3/11/22 and 10-K 2021 financial data.

A PEBV ratio of 0.5 means that the market expects profits in the telecommunications services sector to fall by 50% from 2021 levels. On the other hand, investors expect that the real estate and industrials sectors (PEBV ratios of 3.9 and 1.9) improve their earnings more than any other sector in the S&P 500.

Below, I highlight the consumer staples sector.

Example of sector analysis: Consumer staples: Rolling PEBV ratio = 0.9

Figure 1 shows that the rolling PEBV ratio for the Consumer Staples sector fell from 0.8 on 03/31/21 to 0.9 on 03/11/22. The market capitalization of the consumer staples sector was virtually unchanged at $2.4 trillion from 3/31/21 to 3/11/22, while its economic book value fell from $3.1 trillion on 31/31. /03/21 to $2.7 trillion as of 3/11/22.

Figure 1: Rolling PEBV ratio of non-cyclical consumer goods: December 2004 – 03/11/22

The March 11, 2022 measurement period uses price data on that date and incorporates financial data for 10-K 2021, as this is the earliest date for which all 10-K 2021 calendar for constituents of the S&P 500 were available.

Figure 2 compares trends in market capitalization and economic book value for the consumer staples sector since 2004. I summarize the individual S&P 500/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: Market Capitalization and Economic Book Value of Consumer Staples: December 2004 – 3/11/22

The March 11, 2022 measurement period uses price data on that date and incorporates financial data for 10-K 2021, as this is the earliest date for which all 10-K 2021 calendar for constituents 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, I compare the aggregate method for the trailing PEBV ratio with two other market-weighted methodologies: market-weighted measures and market-weighted drivers. 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: Consumer Staples Trailing PEBV Ratio Methodologies Compared: December 2004 – 03/11/22

The March 11, 2022 measurement period uses price data on that date and incorporates financial data for 10-K 2021, as this is the earliest date for which all 10-K 2021 calendar for constituents of the S&P 500 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 S&P 500/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 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, 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 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. I 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

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. I multiply the market capitalization and the economic book value of each company by its weight
  3. I sum the weighted market cap 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

Advantages:

  • Direct insight into the entire S&P 500/sector, regardless of company size or index 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

Advantages:

  • 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.

Market-weighted factor method

Advantages:

  • 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] I calculate these metrics 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 I call the “aggregate” methodology.

[2] My research is based on the latest audited financial data, which is 10-K 2021 in most cases. Price data is as of 3/11/22.

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