Three All Cap Index Sectors Trade Below Economic Book Value Post 3Q21 Earnings

This report is an abridged and free version of All Cap Index & Sectors: Price to Economic Book Value Through 3Q21, one of my quarterly series on fundamental market and sector trends.

Key Points:

• The trailing PEBV ratio for the NC 2000[1], my firm’s All Cap Index, fell from 1.7 in 3Q20 to 1.5 in 3Q21, implying constituent profits will increase 50% from 3Q21 levels in the long run.
• Investors are most pessimistic about the Telecom Service sector’s outlook where stocks are priced for a decline in profits of 50% from 3Q21 over the long run.
• The full version of this report analyzes[2]^,[3] market cap, economic book value, and the trailing price-to-economic book value (PEBV) ratio for the NC 2000 and each of its sectors.

NC 2000 Trailing PEBV Ratio Fell in 3Q21

The trailing PEBV ratio for the NC 2000 fell from 1.7 in 3Q20 to 1.5 in 3Q21. This trailing PEBV ratio compares the NC 2000’s expected future profits (embedded in its equity valuation) to TTM profits in 3Q21. At 1.5, the NC 2000’s valuation implies the profits of the NC 2000 stocks will increase 50% from 3Q21 levels.

Key Details on Select NC 2000 Sectors

Among NC 2000 sectors, Telecom Services, Consumer Non-cyclicals, and Financials, trade below their economic book value and Basic Materials trades at its economic book value. The Telecom Services sector has the lowest trailing PEBV ratio among the eleven All Cap Index sectors based on prices as of 11/16/21 and financial data from 3Q21 10-Qs.

A trailing PEBV ratio of 0.5 means investors expect the Telecom Service sector’s profits as of 3Q21 to decline by 50%. On the flip side, investors expect the Real Estate sector (trailing PEBV ratio of 3.4) to improve profits more than any other All Cap Index sector.

Below, I highlight the Healthcare sector.

Sample Sector Analysis[4]: Healthcare: Trailing PEBV Ratio = 1.2

Figure 1 shows the trailing PEBV ratio for the Healthcare sector fell from 1.5 in 3Q20 to 1.2 in 3Q21. The Healthcare sector market cap rose from $5.1 trillion in 3Q20 to $6.0 trillion in 3Q21, while its economic book value rose from $3.4 trillion in 3Q20 to $5.0 trillion in 3Q21.

Figure 1: Healthcare Trailing PEBV Ratio: December 1998 – 11/16/21

The November 16, 2021 measurement period uses price data as of that date and incorporates the financial data from 3Q21 10-Qs, as this is the earliest date for which all the 3Q21 10-Qs for the NC 2000 constituents were available. 

Figure 2 compares the market cap and economic book value trends for the Healthcare sector since 1998. I sum the individual NC 2000/sector constituent values for market cap and economic book value. I call this approach the “Aggregate” methodology, and it matches S&P Global’s (SPGI) methodology for these calculations.

Figure 2: Healthcare Market Cap & Economic Book Value: December 1998 – 11/16/21

The November 16, 2021 measurement period uses price data as of that date and incorporates the financial data from 3Q21 10-Qs, as this is the earliest date for which all the 3Q21 10-Qs for the NC 2000 constituents were available. 

The Aggregate methodology provides a straightforward look at the entire NC 2000/sector, regardless of firm size or index weighting, and matches how S&P Global (SPGI) calculates metrics for the S&P 500.

For additional perspective, I compare the Aggregate method for trailing PEBV ratio with two other market-weighted methodologies. These market-weighted methodologies add more value for ratios that do not include market values, e.g. ROIC and its drivers, but I include them here, nonetheless, for comparison. Each method has its pros and cons, which are detailed in the Appendix.

Figure 3 compares these three methods for calculating the Healthcare sector’s trailing PEBV ratios.

Figure 3: Healthcare Trailing PEBV Ratio Methodologies Compared: December 1998 – 11/16/21

The November 16, 2021 measurement period uses price data as of that date and incorporates the financial data from 3Q21 10-Qs, as this is the earliest date for which all the 3Q21 10-Qs for the NC 2000 constituents were available. 

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

Appendix: Analyzing Trailing PEBV Ratio with Different Weighting Methodologies

I derive the metrics above by summing the individual NC 2000/sector constituent values for market cap and economic book value to calculate trailing PEBV ratio. I call this approach the “Aggregate” methodology.

The Aggregate methodology provides a straightforward look at the entire NC 2000/sector, regardless of firm size or index weighting, and matches how S&P Global (SPGI) calculates metrics for the S&P 500.

For additional perspective, I compare the Aggregate method for trailing PEBV ratio with two other market-weighted methodologies. These market-weighted methodologies add more value for ratios that do not include market values, e.g. ROIC and its drivers, but I include them here, nonetheless, for comparison:

Market-weighted metrics – calculated by market-cap-weighting the trailing PEBV ratio for the individual companies relative to their sector or the overall NC 2000 in each period. Details:

1. Company weight equals the company’s market cap divided by the market cap of the NC 2000 or its sector
2. I multiply each company’s trailing PEBV ratio by its weight
3. NC 2000/Sector trailing PEBV ratio equals the sum of the weighted trailing PEBV ratios for all the companies in the NC 2000/sector

Market-weighted drivers – calculated by market-cap-weighting the market cap and economic book value for the individual companies in each sector in each period. Details:

1. Company weight equals the company’s market cap divided by the market cap of the NC 2000 or its sector
2. I multiply each company’s market cap and economic book value by its weight
3. I sum the weighted market cap and weighted economic book value for each company in the NC 2000/each sector to determine the NC 2000 or sector’s weighted market cap and weighted economic book value
4. NC 2000/Sector trailing PEBV ratio equals weighted NC 2000/sector market cap divided by weighted NC 2000/sector economic book value

Each methodology has its pros and cons, as outlined below:

Aggregate method

Pros:

• A straightforward look at the entire NC 2000/sector, regardless of company size or weighting.
• Matches how S&P Global calculates metrics for the S&P 500.

Cons:

• Vulnerable to impact of companies entering/exiting the group of companies, which could unduly affect aggregate values. Also susceptible to outliers in any one period.

Market-weighted metrics method

Pros:

• Accounts for a firm’s market cap relative to the NC 2000/sector and weights its metrics accordingly.

Cons:

• Vulnerable to outlier results from a single company disproportionately impacting the overall trailing PEBV ratio, as I’ll show below.

Market-weighted drivers method

Pros:

• Accounts for a firm’s market cap relative to the NC 2000/sector and weights its size and economic book value accordingly.
• Mitigates the disproportionate impact of outlier results from one company on the overall results.

Cons:

• More susceptible to large swings in market cap or economic book value (which can be impacted by changes in WACC) period over period, particularly from firms with a large weighting in the NC 2000/Sector.

[1] The NC 2000 consists of the largest 2000 U.S. companies by market cap in my firm’s coverage. Constituents are updated on a quarterly basis (March 31, June 30, September 30, and December 31). I exclude companies that report under IFRS and non-U.S. ADR companies.

[2] I calculate these metrics based on S&P Global’s (SPGI) methodology, which sums the individual NC 2000 constituent values for market cap and economic book value before using them to calculate the metrics. I call this the “Aggregate” methodology.

[3] My firm’s research is based on the latest audited financial data, which is the 3Q21 10-Q in most cases. Price data is as of 11/16/21.

[4] The full version of this report provides analysis for every sector like what I show for this sector.