DAY HAGAN RESEARCH UPDATE
AN ALTERNATIVE MEASURE OF VALUATION
One measure of valuation shows the S&P 500 pricing in 3.5 percent earnings growth for the next 5 years.
September 21, 2016
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The Price-to-Earnings ratio (P/E) is one of the most popular metrics used when determining the value of a stock because of its ease to calculate and interpret. While we find the P/E ratio to be a somewhat useful valuation tool, we view intrinsic value calculations to be more worthwhile, albeit more complex to compute. At Day Hagan, we like to use intrinsic value calculations as a way to determine what the market is currently expecting for a stock or sector. In the table below you can see what we deem to be the current earnings growth projections for the next 5 years for the S&P 500 along with each of the sectors within it. We tend to find the sectors with the lowest expectations on a relative and absolute basis to be the most attractive from a valuation standpoint, because they have a low bar to overcome in order to meet the market’s expectations.
As you can see, for example, we calculate that the market is now pricing in 3.50 percent earnings growth for the S&P 500 for the next 5 years. While this is an inexact calculation, the goal is to get an idea of what is priced in, and what would have to occur for the market to do better or worse than currently expected. You will also note that for the past 5 years, S&P 500 earnings growth has averaged 4.11 percent, so the expectations for the next 5 years are below what has actually occurred over the past 5 years.
From a low-expectations perspective, we view Financials, Telecom, Industrials and Consumer Discretionary sectors as being “under-appreciated”. In other words, the perceptions of these sectors are very pessimistic, even when viewed relative to their past 5 years of actual earnings growth results.
From a high-expectations perspective, we view Materials and Utilities as sectors that have a lot of optimism around them. In other words, they have high earnings growth expectations compared to the other sectors, as well as their own earnings growth’s from the past 5 years.
To be clear, this is only a general exercise for us to understand another facet of market expectations and valuation. Our intrinsic value work currently indicates that the “opportunity set” of attractive sectors and individual stocks is limited. Within our U.S. allocation in the Tactical Global ETF strategy, we hold overweight positions in the Financial, Information Technology, Consumer Discretionary and Industrial sectors through sector and style ETFs. We remain neutral to mildly bullish in our overall view of the global equity markets.
Have a wonderful week,
Day Hagan Asset Management
Day Hagan Investment Research
— Written 9.20.2016
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