In our post last week, we discussed the expectations that are currently “priced-in” to the S&P 500 index, or what the index needs to deliver in Sales Growth, EBITDA Margin, and Asset Turnover over the next 5 years in order to justify its current levels. By understanding the embedded expectations an index must deliver to justify its current trading price, investors can develop a “hurdle rate” to quickly determine if the index’s expectations are rich or low. When we compared the current expectations for revenue growth relative to the median growth that the S&P 500 has delivered over the past 5 years, we concluded that the index currently looks fairly valued to slightly overvalued.
When we drill down one step further to the sector level we can help investors identify which sectors have the lowest expectations and thus look undervalued. When allocating across sectors or searching for investment opportunities, focusing on the sectors with the lowest expectations can provide an advantage to investors as these sectors are most likely to meet expectations, contain more attractive investment opportunities for individual stocks and deliver adequate returns.
The chart below displays Implied Future Sales Growth and Historical Sales Growth for each AFG sector in the S&P500. The sectors are ranked from left to right with the most undervalued sectors on the left. The three sectors with the lowest delta between sales growth expectations and historical performance, or the three most undervalued sectors are Healthcare, Transportation and Technology.
We will follow up next week with some individual companies with reasonable expectations from the Technology sector with the lowest expectations that also look attractive from a valuation and Investment Grade standpoint.
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