With Valuations Rich, Investors Hard To Impress

7/31/2017


The Dow Transports have slumped on disappointing airline and railroad results, and the reaction of individual stocks to earnings news has been somewhat disappointing. Still, with the Dow Theory squarely in the bullish camp, our buy lists have more than 94% in stocks.

Downbeat reaction

An unusually high proportion of U.S. companies are exceeding consensus earnings estimates for the June quarter, and the amount by which they are beating estimates is bigger than normal. The same is true for sales.

In fact, more than three-fourths of S&P 500 companies have exceeded consensus sales targets. If that level is sustained for the full reporting period, it would mark a new high since data began in 2008, according to FactSet.

Still, the reaction to June-quarter results has been mostly subdued. The S&P 500 Index and broad market have edged higher since earnings season began. Shares of companies posting positive profit surprises have seen meager rallies, on average.

The average first-day gain for stocks with positive profit surprises has been less than 1%, according to Bespoke Investment Group. Meanwhile, those with downside surprises have seen declines averaging 4%.

Why the downbeat reaction?

• First, profit surprises have become commonplace, and the weak dollar is partly responsible for the jump in sales surprises. 

• Second, guidance for the third quarter has been somewhat disappointing. As a result, consensus third-quarter profit expectations for the S&P 500 Index have dropped more than is typical at this stage of the second-quarter reporting season.

• Third, stocks are expensive, as shown in the table below. The median stock in the broad S&P 1500 Index trades at 21.5 times trailing earnings — 18% above the norm since 1994 and higher than 98% of month-ends since 1994. Of the 11 S&P 1500 sectors, eight trade at least 19% above the norm based on median P/E.

S&P 1500 SECTOR VALUATIONS, SORTED BY P/E RELATIVE TO NORM
S&P
1500
Energy
Telecom
Utilities
Health
Care
Industrials
Materials
Cons.
Staples
Financials
Tech-
nology
Cons.
Discret.
Real
Estate*
Recent median
trailing P/E
21.5
31.3
29.0
20.9
29.0
23.3
21.4
23.6
17.8
25.2
17.3
27.4
Norm since 1994
18.2
18.0
19.3
15.6
22.4
18.3
17.4
19.5
15.0
24.4
17.4
30.2
Premium to norm
since 1994 (%)
18
73
50
34
29
27
23
21
19
3
(1)
(9)
% of month-ends
with lower P/E
98
100
99
98
97
97
94
92
92
65
41
30
* Data for real estate sector began 10/31/01.

As shown below, only 13% of all S&P 1500 stocks have P/Es below 14, below the norm of 24% since 1994.

Conclusion

With stock valuations expensive, companies are having a harder time impressing investors. Still, with the Dow Industrials and S&P 500 and Russell 2000 indexes reaching all-time highs in late July, it's tough to call this reporting season a big disappointment. So far, actual second-quarter results suggest the rebound in corporate earnings growth remains intact.


BREAKDOWN OF STOCKS BY P/E RANGE

-------------- % Of Stocks With Trailing P/E Of --------------
0 To 10
10 To 14
14 To 18
18 To 22
Over 22
Or NM
S&P 500 (large-cap)
Recent
2
11
20
20
47
Norm since 12/94
8
17
22
17
36
S&P 1500 (all-cap)
Recent
4
9
18
18
50
Norm since 12/94
8
16
21
16
39

 


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