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

This post was originally published on this site

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 sector trends.

The report analyzes[1] market cap, economic book value, and the trailing price-to-economic book value (PEBV) ratio for the S&P 500 and each of its sectors (last quarter’s analysis is here). My firm’s research is based on the latest audited financial data, which is the 2Q21 10-Q for most companies. Price data is as of 8/18/21.

These reports leverage  fundamental data that overcomes flaws with legacy fundamental datasets. Investors armed with Core Earnings data feed enjoy idiosyncratic alpha.

S&P 500 Trailing PEBV Ratio Rose Year-over-Year

The trailing PEBV ratio for the S&P 500 rose from 1.4 in 2Q20 to 1.5 as of 8/18/21, the earliest date all S&P 500 companies provided 2Q21 quarterly data. The S&P 500 trailing PEBV ratio was around this level for much of 2017-2019, before drastically falling in early 2020. This trailing PEBV ratio compares the S&P 500’s expected future profits (embedded in its equity valuation) to TTM profits in 2Q21. At 1.5, the S&P 500’s valuation implies the profits (NOPAT) of the S&P 500 will increase 50% from 2Q21 levels.

Key Details on Select S&P 500 Sectors

Two S&P 500 sectors, Telecom Services and Consumer Non-cyclicals, trade below their economic book value. The Telecom Services sector has the lowest trailing PEBV ratio among all 11 S&P 500 sectors based on prices as of 8/18/21 and financial data from 2Q21 10-Qs.

MORE FOR YOU

A trailing PEBV ratio of 0.5 means the market expects the Telecom Services sector’s profits as of 2Q21 to decline by 50% from current levels. On the flip side, investors expect the Energy and Real Estate sectors (trailing PEBV ratios of 17.6 and 3.6) to improve profits more than any other S&P 500 sectors. Below, I highlight the Telecom Services sector, which has the lowest PEBV ratio of the S&P 500 sectors.

Sample Sector Analysis[2]: Telecom Services: Trailing PEBV Ratio = 0.5

Figure 1 shows the trailing PEBV ratio for the Telecom Services sector fell from 0.8 in 2Q20 to 0.5 in 2Q21. The Telecom Services sector market cap rose from $730 billion in 2Q20 to $760 billion in 2Q21, while its economic book value rose from $957 billion in 2Q20 to $1.4 trillion in 2Q21.

Figure 1: Telecom Services Trailing PEBV Ratio: December 2004 – 8/18/21

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

Figure 2 compares the market cap and economic book value trends for the Telecom Services sector since 2004. I sum the individual S&P 500/sector constituent values for market cap and economic book value. I call this approach the “Aggregate” methodology, and it matches S&P Global’s (SPGI) methodology for these calculations.

Figure 2: Telecom Services Market Cap & Economic Book Value: December 2004 – 8/18/21

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

The Aggregate methodology provides a straightforward look at the entire S&P 500/sector, regardless of firm size or index weighting, and matches how S&P Global (SPGI) calculates metrics for the S&P 500.

For additional perspective, I compare the Aggregate method for trailing 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, e.g. ROIC and its drivers, but I include them here, nonetheless, for comparison. Each method has its pros and cons, which are detailed in the Appendix.

Figure 3 compares these three methods for calculating the Telecom Services sector trailing PEBV ratio.

Figure 3: Telecom Services Trailing PEBV Ratio Methodologies Compared: December 2004 – 8/18/21

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

Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

Appendix: Analyzing Trailing PEBV Ratio with Different Weighting Methodologies

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

The Aggregate methodology provides a straightforward look at the entire S&P 500/sector, regardless of firm size or index weighting, and matches how S&P Global (SPGI) calculates metrics for the S&P 500.

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

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

  1. Company weight equals the company’s market cap divided by the market cap of the S&P 500 or its sector
  2. I multiply each company’s trailing PEBV ratio by its weight
  3. S&P 500/Sector trailing PEBV equals the sum of the weighted trailing PEBV ratios for all the companies in the S&P 500/sector

Market-weighted drivers – calculated by market-cap-weighting the market cap and economic book value for the individual companies in each sector in each period. Details:

  1. Company weight equals the company’s market cap divided by the market cap of the S&P 500 or its sector
  2. I multiply each company’s market cap and economic book value by its weight
  3. I sum the weighted market cap and weighted economic book value for each company in the S&P 500/each sector to determine the S&P 500 or sector’s weighted FCF and weighted enterprise value
  4. S&P 500/Sector trailing PEBV ratio equals weighted S&P 500/sector market cap divided by weighted S&P 500/sector economic book value

Each methodology has its pros and cons, as outlined below:

Aggregate method

Pros:

  • A straightforward look at the entire S&P 500/sector, regardless of company size or weighting in any indices.
  • Matches how S&P Global calculates metrics for the S&P 500.

Cons:

  • Vulnerable to impact of companies entering/exiting the group of companies, which could unduly affect aggregate values. Also susceptible to outliers in any one period.

Market-weighted metrics method

Pros:

  • Accounts for a firm’s market cap relative to the S&P 500/sector and weights its metrics accordingly.

Cons:

  • Vulnerable to outlier results from a single company disproportionately impacting the overall trailing PEBV ratio, as I’ll show below.

Market-weighted drivers method

Pros:

  • Accounts for a firm’s market cap relative to the S&P 500/sector and weights its size and economic book value accordingly.
  • Mitigates the disproportionate impact of outlier results from one company on the overall results.

Cons:

  • More susceptible to large swings in market cap or economic book value (which can be impacted by changes in WACC) period over period, particularly from firms with a large weighting in the S&P 500/Sector.

[1] I calculate these metrics based on S&P Global’s (SPGI) methodology, which sums the individual S&P 500 constituent values for market cap and economic book value before using them to calculate the metrics. I call this the “Aggregate” methodology. Get more details in Appendices I and II.

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