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Up early with this guy, so some thoughts on value and value’s valuation (all data from Morningstar):
1/ S&P 500 is trading at a p/e of 22, P/b of 3.5 and p/s of 2.6.
This all seems expensive historically but comparisons are tough as the composition of the index has changed over time. For example, tech now 24% of index and tech has higher margins & deserves higher multiples.
This all seems expensive historically but comparisons are tough as the composition of the index has changed over time. For example, tech now 24% of index and tech has higher margins & deserves higher multiples.
2/ We can attempt to lower the valuations by focusing on the 500 value index. This has p/e of 17, p/b of 2 and p/s of 1.7.
On the surface, this looks much cheaper than the index! Mission accomplished?
On the surface, this looks much cheaper than the index! Mission accomplished?
3/ On the surface, it looks like a 31% discount to the index. However the point of value is to buy mispriced expectations not just low valuations.
How do we isolate what are mispriced expectations vs just lower multiples? A good first step is to adjust for sectors.
How do we isolate what are mispriced expectations vs just lower multiples? A good first step is to adjust for sectors.
4/ When we use the market cap weighted sectors and the weights of of 500 value index in each, we get a p/e of 19.5, p/b of 2.5 and p/s of 2.1.
Note - remember to convert from multiple to yield, multiply by weight then take inverse to convert.
Note - remember to convert from multiple to yield, multiply by weight then take inverse to convert.
5/ What this means is that the sector changes make a lot of difference in the valuations or about 50% of the valuation difference.
500 value index p/e is 17 compared to 19.5 for market cap weighted with same sector mix which compares to 22 for 500 index.
500 value index p/e is 17 compared to 19.5 for market cap weighted with same sector mix which compares to 22 for 500 index.
6/ Clearly, value multiple isn’t all expectations related. So value is really only trading at a 12% discount on p/e basis after adjusting for sectors...not that cheap!
7/ if we look at at earnings weighted 500 index, we see that it trades at a 17.5 p/e, 3 p/b and 2 p/s. This seems much more expensive, right?
Well, it’s sector composition is very different and much closer to the index.
Well, it’s sector composition is very different and much closer to the index.
8/ When we use market cap sectors and the weights in the earnings weighted index we get a comparable of 20 p/e, 3 p/b and 2.4 p/s.
This means that on a p/e basis the earnings weighted 500 is trading 12.7% cheap to its sector equivalent.
This means that on a p/e basis the earnings weighted 500 is trading 12.7% cheap to its sector equivalent.
Fin/ The cheapness of the earnings weighted index is actually larger to its sector equivalent than the 500 value index! Also, it accomplishes this cheapness with less sector difference.
Point being - know what you own, why you own it and might need to look deeply to really know.
Point being - know what you own, why you own it and might need to look deeply to really know.
