S&P 500 Sector Expectations - October 2009

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The Applied Finance Group's (AFG's) Value Expectations (VE) interface is useful in understanding the imbedded sales growth a company needs to achieve over the next 5 years to justify its current stock price. Measuring the spread between a company’s imbedded sales growth expectation (Implied Sales Growth) and what it has historically delivered (5 year historical median) provides a basis to determine which stocks have relatively low expectations and thus are more likely to outperform.

When using the VE interface to solve for the implied sales growth for every company within the S&P500, we found that the average implied sales growth for the overall index is 4.94%. This is less than the S&P500’s 5-year median for sales growth of 12.25%, which would suggest the index is still undervalued. The chart below displays this comparison, as well as the implied sales growth vs. historical sales growth for each sector within the index.

Our results indicate that the Energy and Financial sectors have the largest spread between imbedded sales growth expectations and the 5 year median, which would suggest these sectors have relatively low implied sales growth expectations, and thus are more likely to outperform. On the other end of the spectrum, the Utilities and Consumer Non-Durable sectors seem to have the loftiest sales growth expectations embedded in their current stock price. Thus, these sectors seem least likely to outperform based on current expectations.

*AFG’s Value Expectations allows us to understand the Sales Growth, EBITDA Margin, and Asset Turnover a company has to deliver in the future to justify its current trading price. In theory and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future Sales Growth of the list of companies assuming their EBITDA Margins and Asset Turnovers stay at the 5 year median levels.

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