Looking Back To Find Value

6/6/2011


Is the stock market cheap relative to historical norms?

It sounds like a simple question, but as is so often the case with the market, the answer depends on your perspective.

Near-sighted: For the 12 months ended March, S&P 500 Index earnings totaled an estimated $82 per share including special items — up more than tenfold from the same period two years ago and the highest profit in three-and-a-half years. At 16 times those earnings, the S&P 500 Index trades at a substantial discount to the norms of 35 over the last five years and 28 over the last 20 years. The index hasn't traded at such a low valuation relative to inflation-adjusted earnings at month-end since January 1991.

Far-sighted: Over the last 10 years, a period that includes a deep recession, S&P 500 Index earnings have averaged $57.68 per share. The P/E based on 10-year average earnings is 23 — slightly higher than the five-year average of 22 for that metric, though below the 20-year average of 26. Over the last 50 years, the S&P 500 has traded at average P/E based on 10-year average earnings of 19, according to Yale University professor Robert Shiller, on whose work we are relying for the S&P 500 numbers.

Worth noting is that Shiller uses inflation-adjusted earnings, without excluding any special items. That means the huge losses recorded at the depth of the financial crises in 2008 and 2009 are depressing 10-year average earnings, making stocks look relatively expensive compared to measures that focus on operating earnings.

Proponents of the Shiller P/E argue that excluding special items goes against the whole idea of using 10-year average earnings, which are designed to avoid distortions from short-term earnings swings and incorporate all results over the course of a business cycle.

Shiller critics argue that the huge write-downs seen in the financial sector were a once-in-a-lifetime event, so using them to estimate 'normalized' earnings is foolhardy.

Looking ahead, this debate highlights a central issue dividing stock-market bulls and bears: the sustainability of corporate profits. Consensus estimates project per-share-profit growth of 17% for the S&P 500 Index this year, followed by 13% in 2012. For the 12 months ended March, the index's per-share earnings were about 43% higher than the average for the last 10 years. Trailing earnings have exceeded the 10-year average by a higher percentage in only 8% of the months since 1960.

SIZE AND SECTOR ANALYSIS
The 379 components of the S&P 500 Index that earned a profit over the last year and have a decade of earnings history trade at an average of 17.7 times trailing earnings and 25.9 times average inflation-adjusted earnings over the last 10 years. On average, stocks trade at a discount to their 10-year average P/E on both earnings metrics. While the giant stocks that make up a disproportionate share of the capitalization-weighted index are substantially cheaper than the rest on both an absolute and relative basis, the smaller stocks also look reasonably valued relative to historical norms.
Average For 379 Stocks In S&P 500 Index
Trailing P/E Ratio
P/E On 10-Yr. Avg. EPS
S&P 500 Index (No. of Stocks)
Current
10-Yr.
Avg.
Curr.
Vs. 10-
Yr. Avg.
Current
10-Yr.
Avg.
Curr.
Vs. 10-
Yr. Avg.
Stock-Market Value
$50 Billion And Up (43)
15.1
18.7
0.84
22.4
24.7
0.84
$10 Bil. To $50 Bil. (190)
17.5
19.8
0.89
26.4
25.7
0.92
Below $10 Billion (146)
18.7
19.8
0.91
26.2
25.9
0.97
Sectors
Cons. Discretionary (59)
17.8
19.9
0.91
26.2
26.2
0.92
Consumer Staples (36)
17.3
18.7
0.95
23.6
25.2
0.90
Energy (32)
23.7
18.4
1.12
27.0
27.9
0.79
Financials (58)
16.5
20.6
0.81
21.9
22.2
0.89
Health Care (40)
15.2
21.0
0.75
29.2
32.6
0.80
Industrials (55)
19.3
19.6
0.95
28.2
25.2
1.02
Materials (24)
20.5
19.0
0.94
29.7
25.6
1.10
Technology (44)
15.6
24.4
0.63
31.2
34.1
0.91
Telecom Services (4)
16.9
15.1
0.98
16.2
15.7
1.03
Utilities (27)
14.5
14.1
1.04
16.0
16.6
0.98
All 379 Stocks
Average (379)
17.7
19.7
0.89
25.9
25.6
0.93
Median (379)
17.1
19.3
0.90
25.3
27.3
0.89
Note: Averages exclude P/E ratios below 0 or above 75.

We tend to side with the bulls regarding the outlook for corporate profits, partly because U.S. companies have become less reliant on the struggling U.S. consumer. Still, with corporate profit margins already at all-time highs and growth overseas showing signs of slowing, sustaining double-digit profit growth will become increasingly difficult without some acceleration in U.S. economic growth.

To help keep the odds in your favor, avoid chasing richly valued shares of companies with the fastest expected growth rates. Instead, look for companies with sustainable profits and the potential to exceed consensus expectations.

Consider P/E ratios based on trailing, expected, and 10-year average earnings, and consider valuations relative to historical norms. Listed in the table below and reviewed below are stocks trading at a discount to their three- and 10-year average valuation as measured by average earnings (excluding special items) over the previous 10 years.

Aflac ($48; AFL) earns a stellar Quadrix Value score of 98, ranking it among the cheapest 3% of U.S.-traded stocks. Moreover, the shares trade at 16.1 times 10-year average earnings, versus the three-year average of 20.2 and 10-year norm of 26.6 for that metric. Aflac earns a respectable 82 Overall score — above the average of 69 for the 26 life and health insurers in our research universe.

Management tempered its growth outlook last month, saying per-share profits should climb only 8% in 2011, followed by a 0% to 5% gain next year. Wall Street analysts (21 provide earnings estimates) remain upbeat on the current year, projecting earnings per share will climb 12% to $6.21, up from $6.17 a month ago. For 2012, the consensus is $6.45, down from the $6.69 expected a month ago. 

Aflac is setting the stage for sustainable growth and improved financial flexibility. Asset sales have eliminated some bank and sovereign debt from financially tenuous regions and trimmed some of the largest holdings in its investment portfolio. Notably, during the March quarter, the insurer sold some of its Greek debt. Aflac is a Focus List Buy and Long-Term Buy.


Hess ($79; HES) is riding oil's price momentum. March-quarter earnings per share rose 22% on a 14% revenue gain, buoyed by a 37% increase in oil prices. The company's exploration-and-production unit is positioned for additional gains, partly reflecting strong exploration results in Australia and Ghana. Importantly, the 2011 consensus per-share-profit estimate of $7.61 could prove conservative if oil prices hold their ground or keep rising. Last year, the company earned $5.15 per share. For 2012, the consensus is $8.31, up from $7.88 two months ago. 

Hess, with its production unhedged, is particularly sensitive to fluctuations in oil prices. Moreover, the company's growth comes in spurts, reflecting the cyclical nature of its markets.

Still, the stock appears to discount those issues. Shares trade at 17.3 times 10-year average earnings, compared to an average of 18.8 for that same metric over the last three years and an average of 22.9 over the last 10 years. Hess earns a Value score of 89, and the shares trade at an attractive 10 times estimated current-year earnings. Hess is a Focus List Buy and Long-Term Buy.

HISTORICAL VALUES
All 13 A-rated stock trade at a P/E on 10-year average earnings that is below the three-year and 10-year average for that metric. Companies recommended for purchase are presented in bold.
Earnings
Per Share
Trailing P/E
P/E On 10-Yr. Avg. EPS
Quadrix
Scores
Company (Price; Ticker)
Last 12
Mos.
($)
10-Yr.
Avg.
(Inflation
Adjusted)
($)
Curr.
3-Yr.
Avg.
(Inflation
Adjusted)
10-Yr.
Avg.
(Inflation
Adjusted)
Curr.
3-Yr.
Avg.
(Inflation
Adjusted)
10-Yr.
Avg.
(Inflation
Adjusted)
Value
Overall
Sector
Abbott Labs
($52; ABT)
4.27
2.43
12
15
23
21
25
27
86
90
Health Care
Adobe Systems
($35; ADBE)
2.12
1.04
16
28
37
33
36
49
69
90
Technology
Aflac ($48; AFL)
5.76
2.96
8
14
20
16
20
27
98
82
Financials
Baxter Int'l
($60; BAX)
4.03
2.28
15
16
22
26
30
33
69
88
Health Care
Dell ($16; DELL)
1.85
1.21
9
13
28
13
14
37
96
99
Technology
Energen
($62; EGN)
4.06
3.03
15
12
16
21
20
25
48
69
Energy
Exelon ($42; EXC)
4.23
3.18
10
13
16
13
21
24
85
60
Utilities
Exxon Mobil
($83; XOM)
7.03
5.46
12
12
16
15
17
21
85
97
Energy
General Dynamics
($74; GD)
6.93
4.69
11
11
18
16
19
23
89
80
Industrials
Hess ($79; HES)
5.48
4.56
14
14
12
17
19
23
89
89
Energy
Microsoft
($25; MSFT)
2.46
1.44
10
14
29
17
22
35
93
92
Technology
St. Jude Medical
($51; STJ)
3.06
1.49
17
17
30
34
37
49
64
76
Health Care
Wal-Mart Stores
($55; WMT)
4.18
3.06
13
16
26
18
22
32
86
88
Cons. Staples
Note: Quadrix scores are percentile ranks, with 100 the best.

 


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com