05/23/2017

Is the S&P 500 Overvalued?

One unique set of insights that we provide to our clients is understanding the expectations that are baked-in to the current price of a stock. One particularly important set of data to understand is imbedded sales growth expectations, or essentially what a company needs to deliver in sales growth over the next 5 years to justify its current trading price.

AFG’s Value Expectations interface essentially “reverse engineers” what a company needs to deliver in sales growth over the next 5 years (assuming 5 Year Median Margins and Asset Turns) to justify its current trading price. The Implied Sales Growth then serves as the “Hurdle Rate” for the stock to determine how likely a firm will be to deliver the sales growth necessary to deliver adequate returns for investors. Companies with the highest hurdle rates have proven to be more likely to underperform than companies with realistic expectations for priced-in sales growth.

When we aggregate this expectations data for the entire for a sector or an entire index like the S&P 500 we can get an estimate of how attractive the segment of the market looks as a whole, and can identify when expectations move outside of normal range (-1.5/+1.5 StdDev). When the implied sales growth moves outside the -1.5/+1.5 StdDev threshold it signals extreme valuation levels and an opportunity to advise clients to either enter/exit or reduce/increase exposure to a segment of the market.

Currently the median company in the S&P500 is priced to grow revenue by around 10% over the next 5 years, while the median company has delivered just under 8% revenue growth on average over the past 5 years. This signals that the index is currently slightly overvalued yet still well within the normal valuation range. There are still plenty of opportunities present in the large cap space and no adjustments should be made in regards to exposure to large cap stocks.

As always we will continue to monitor this chart and provide updates regularly or when the implied sales growth moves outside the normal range boundaries. In the coming weeks we will break down the expectations for sales growth of every sector within the S&P 500 index and identify the sectors that look most attractive.

To learn more about our Value Expectations interface and how investment firms use this data to more efficiently manage equity portfolios email us at Sales@afgltd.com.