Another Look at Valuations


Why Playing Defense May Be More Expensive

The sideways market paradox continues. While earnings, cash balances and other corporate metrics have improved dramatically over the last decade, the market itself has been range bound and volatile due to the excessive valuations that resulted from the tech boom. To be sure, we are 12 years into working off those excessive valuations, and the ride has been, to say the least, difficult at times.

We pay a lot of attention to earnings, and you can find our most recent analysis here. While earnings are near all-time highs, we wanted to detail the fact that many other metrics confirm and support the growth we have seen in earnings. Chart 1 shows sales, book value and dividends per share for the S&P 500 since 2000. While the numbers matter, the trend is key. All of the metrics are rising. Sales (i.e., money coming into corporations), book value (i.e., the accounting value of corporate stock) and dividends (i.e., cash payments to shareholders) have all grown. Like we have seen with earnings, some of these metrics have doubled.

Chart 1: Key Metrics Rise Despite Sideways Decade
S&P 500 Select Quarterly Metrics (Q1 2000 – Q2 2012)

Table 1 looks ahead. It plots analyst expectations for earnings growth over the next 5 years as well as select valuation metrics. The key takeaways from the table are:

  • P/E ratio is below its historical average.
  • PEG ratio (price-to-earnings growth) is well within its reasonable range if we view below 1 as value territory and above 2 as expensive.
  • Defensive sectors (e.g., utilities and telecom) that offer little growth have become expensive while cyclical and growth sectors look cheap, especially given growth forecasts.
Table 1: Defensive More Expensive Than Growth
S&P 500 Sector Projected Growth and Valuation Metrics

Our message continues to be that corporate health continues to improve, and if we have no economic disaster—one that would probably be caused by politicians or sovereign debt—valuations remain reasonable.


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