S&P 500 Expectations for Revenue Growth - January 2012

Print ArticleEmail Article

Understanding the embedded expectations in stock prices, or what a company needs to deliver in revenue growth over the next 5 years in order to justify current stock prices, helps investors better understand whether a company's valuations are rich or low. By understanding a company's embedded expectations clients can develop a "hurdle rate" to quickly determine if a company's expectations are realistic.

AFG's Value Expectations interface uniquely enables users to "solve" for the performance expectations a company must deliver in order to justify its current stock price. Our research indicates that companies with low embedded expectations tend to outperform the market, while those with higher expectations tend to underperform.

Today we will apply this methodology to every stock within the S&P500 to assess the overall valuation of the index and also at the sector level to identify which sectors appear the most and least favorable accordingly.

The below graph illustrates the implied sales growth for each sector and the index as a whole, along with the median level of performance actually delivered over the last 5 years. With this data, we can clearly identify that energy, health and financials have low expectations for revenue growth relative to what each sector has delivered in the past, while utilities and consumer services on the other hand have relatively high expectations.

The snapshot below illustrates the S&P 500 expectations vs. what the market has been able to deliver historically. Much like understanding the expectations that are priced into a stock, this chart can help clients better understand whether the market (S&P 500) has high or low expectations currently priced in. This chart can also provide some insight into how the market reacts when expectations are at extreme levels.

Over the past 5 years the companies in the S&P 500 delivered roughly 7% sales growth, on average, while the market currently has 5% revenue growth priced in. If you think the market can deliver better than 5% over the next 5 years then you would be paying for low expectations. If you believe the S&P 500 will deliver less than 5%, the S&P 500 (INDEXSP:.INX) has high expectations.