There are several ways in which we communicate with our clients the overall attractiveness of an entire sector or index with aggregations of data that analyze the valuation attractiveness, market multiples such as Market Value/Invested Capital, and Economic Margins of an entire index or sector. One important set of data to understand is imbedded sales growth expectations, or essentially what a company needs to deliver in revenue growth over the next 5 years in order to justify its current trading price.
We view the implied sales growth as the “hurdle rate” to better understand whether a company, sector or index is likely to deliver the growth necessary to provide adequate return for its investors. When implied sales expectations are high (high hurdle rate) for a company or index relative to what it has delivered historically, it becomes difficult to deliver the growth required for investors to obtain a satisfactory return on their investment. On the contrary, when expectations are low (low hurdle rate) a company has a much easier time meeting the growth requirements to deliver adequate returns to its investors.
When we aggregate the implied sales expectations of every company within the S&P 500 we see that the median company in the S&P500 is priced to grow revenue by around 7% over the next 5 years, while the median company has delivered close to 6% on average over the past 5 years. This signals that the index is currently very close to fairly valued/slightly overvalued.
The chart below highlights current and historical implied sales growth expectations embedded in the market price for the S&P 500 index compared to the sales growth these stocks have delivered over the past five years. When the index approaches abnormal ranges (+/- 1.5 std dev.) it signals that the index is extremely under or overvalued. Most recently, after the major selloff earlier this year the implied sales expectations for the index dipped to nearly 4% (1-15-16), very close to the -1.5 Std Dev. threshold to signal the index was very undervalued. Subsequently the market has rallied tremendously, delivering over 7% returns in the following 3 months.
Now that we have determined that the overall S&P 500 index looks fairly valued based on implied sales growth, we can now highlight a few companies that have high and low expectations.
High Expectations:
WYNN – Wynn Resorts, Limited (NASDAQ:WYNN) is a great example of a company that currently has very high expectations for revenue growth priced in to its current trading price. Historically the company has delivered around -2% sales growth (5 year median) while the company needs to deliver around 7% sales growth over the next 5 years to justify its current price. This seems like very lofty expectations relative to what the company has been able to achieve in the past. Not only does WYNN have very lofty expectations for sales growth but also earns an AFG Investment Grade of “F” and looks overvalued relative to sector and industry peers. We believe there are much better options in the hotel/gaming space than WYNN.
Low Expectations:
XRX – Xerox Corp (NYSE:XRX) is a firm that currently has low expectations for revenue growth imbedded in its current price. Over the past 5 years the company has delivered around -4% (median) revenue growth over the past 5 years. The company is currently priced to deliver nearly -8% revenue growth to justify its current levels. Not only do those expectations look very realistic relative to historical revenue growth, the company also looks very undervalued according to our valuation model and currently earns an Investment Grade of “A”. We believe XRX currently looks like a very attractive investment opportunity.
