Book value

Economic price-to-book value looks cheaper but still not cheap

The S&P 500 rolling PEBV ratio fell from 1.6 on 6/30/21 to 1.2 on 5/16/22 and is at its second lowest level since June 30, 2016.[1],[2]

This report is a free abridged version of S&P 500 & Sectors: Price-to-Economic Book Value Looks Cheaper But Still Not Cheap, one of my quarterly series on fundamental market and sector trends.

S&P 500 trailing PEBV ratio drops to 2016 levels

The 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 05/16/22. The S&P 500 PEBV ratio of 1.2 implies that earnings (NOPAT) of the S&P 500 will increase by 20% between the last twelve months (TTM) and 1Q22 levels.

Key details on selected S&P 500 sectors

Five S&P 500 sectors, telecommunications services, healthcare, financials, basic materials and energy, are trading below their economic book value. The consumer staples sector trades at its economic book value. The telecommunications services sector has the lowest PEBV ratio among the eleven S&P 500 sectors based on 5/16/22 prices and 1Q22 10-Qs financial data.

A PEBV ratio of 0.5 means the market expects telecom services sector earnings to fall 50% from TTM levels through 1Q22. On the other hand, investors expect the real estate and consumer discretionary sectors (trailing PEBV ratios of 3.5 and 1.8) to improve earnings more than any other sector in the S&P 500.

Below, I highlight the basic materials sector.

Example of sector analysis: Basic materials: Final PEBV ratio = 0.9

Figure 1 shows that the rolling PEBV ratio for the basic materials sector fell from 1.9 on 6/30/21 to 0.9 on 5/16/22. The market capitalization of the basic materials sector fell from $1 trillion on 6/30/21 to $871 billion on 5/16/22, while its economic book value fell from $556 billion on 30/06/2019. /06/21 at $960 billion as of 5/16/22.

Figure 1: PEBV ratio of basic materials: December 2004 – 05/16/22

The May 16, 2022 measurement period uses price data on that date and incorporates financial data from 1Q22 10-Qs, as this is the earliest date for which all 1Q22 10-Qs on the calendar for components of the S&P 500 were available.

Figure 2 compares trends in market capitalization and economic book value for the basic materials sector since 2004. I summarize the individual S&P 500/sector constituent 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 basic materials: December 2004 – 05/16/22

The May 16, 2022 measurement period uses price data on that date and incorporates financial data from 1Q22 10-Qs, as this is the earliest date for which all 1Q22 10-Qs on the calendar for components 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 basic materials sector.

Figure 3: Comparison of PEBV ratio methodologies for base materials: December 2004 – 05/16/22

The May 16, 2022 measurement period uses price data on that date and incorporates financial data from 1Q22 10-Qs, as this is the earliest date for which all 1Q22 10-Qs on the calendar for components 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. S&P 500/Sector PEBV trailing equals the sum of weighted PEBV trailing ratios for all S&P 500/sector companies

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 capitalization and the weighted economic book value of each S&P 500 company/each sector to determine the weighted FCF of the S&P 500 or the sector and the weighted company 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:

  • A direct view of the entire S&P 500/sector, regardless of company size or 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, as I will show below.

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 the S&P Global (SPGI) methodology, which sums the individual S&P 500 constituent values ​​for market capitalization and economic book value before using them to calculate the metrics. This is what I call the “aggregate” methodology. Get more details in Annexes I and II.

[2] The analysis in this report is based on the latest audited financial data available, or 1Q22 10-Qs in most cases. Price data for the current period as of 05/16/22.