An Average End To An Anything-But-Average Year

An Average End To An Anything-But-Average Year
Paul Allison, CFA

about 1 year ago2 mins

Mentioned in story

Although 2022 was anything but average, in the end, that’s where the S&P 500 found itself – when it comes to valuations, that is. JPMorgan Asset Management’s taken six popular valuation measures and compared today’s readings to their 25-year averages. The punchline: they’re all either at or very close to their long-term averages.

On two of the measures: price-to-book (P/B) and dividend yield (inset box, above), the index is priced at a slight premium to its 25-year average. But the devil might be in the details here. Take P/B: the firms that dominate today’s index don’t actually produce a lot of stuff. Apple outsources iPhone manufacturing, and other Big Tech firms like Google parent Alphabet and Microsoft are service-oriented, meaning they don’t own a lot of assets relative to the revenue they generate. A firm’s book value is its assets (what it owns) minus its liabilities (what it owes). The fewer the assets, the smaller the book value. And that means the P/B (price divided by book value) of today’s S&P 500 should be higher than its older, asset-heavier generation. It’s also not surprising that the S&P 500’s dividend yield is lower than its long-term average. The tech firms that populate the index today are considered growth firms, and those typically retain their profit rather than dishing it out to shareholders via dividends.

It’s these quirks that lead investors to look at profit-based valuation measures. Profit is profit, after all, regardless of how it’s made or what firms choose to do with it. The chart shows the S&P 500’s forward price-to-earnings (P/E, black line) is nestled on its 25-year average line (green dotted line, center). The cyclically adjusted or CAPE P/E (which uses the prior ten years’ profit) is around its long-term average too (shown in the inset box). And so is the earnings yield spread – that’s the difference between the S&P 500 earnings yield (profit-per-share divided by price) and the medium-risk corporate bonds yield.

That leads us to the sixth valuation metric: price-to-cash flow (P/CF, inset box) – and that one’s still a shade above average, which is cause for a pause. Unlike profit, accounting methods can’t distort cash flow, making it the most important metric when it comes to valuation. And the fact the S&P 500’s hovering above its 25-year P/CF average makes for a less positive perspective and might encourage those looking for a better entry point to sit on their hands, for now.

An average valuation conclusion’s unlikely to settle any arguments between optimists and pessimists, but further price falls from here would tip the S&P 500 index into attractive value territory. And that’d be good news for cash-rich bargain hunters at least.

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