Equity and Quant Strategy Equity and Quant Strategy | United States 11 June 2013 S&P 500 relative value cheat sheet Savita Subramanian Equity & Quant Strategist MLPF&S The multiple swap: yield compressing, cyclicals expanding Last month, valuation multiples expanded across most sectors, but for the more Dan Suzuki, CFA defensive and higher yielding Staples, Telecom and Utilities sectors, we saw a Equity Strategist MLPF&S reversal from earlier this year as P/E’s contracted amid concerns of Fed actions. On relative forward P/E, Utilities is still the most stretched versus its historical average, Alex Makedon but the sector’s premium to the market has fallen to only 6%, compared to an all- Quantitative Strategist time high of 23% in mid-2012. Additionally, amid last month’s sell-off from these MLPF&S bond-proxy sectors, Financials has now surpassed Telecom as the second most overvalued sector vs. history on relative forward P/E (see Table 1 inside). Other Jill Carey high-yielding industries, such as Tobacco and REITs, also saw multiple Equity Strategist MLPF&S compression in May, though they remain among the most expensive industries overall compared to where they have traded historically relative to the S&P. We recently highlighted that the low beta bubble could be beginning to deflate, and advise investors avoid the expensive, high yielding low beta sectors in favor of An historical guide to sector & inexpensive cyclicals with low “fundamental betas” (earnings stability). industry valuation Globally exposed cyclical sectors still cheap For those interested in examining relative value Despite the run-up in May, most globally-oriented cyclical industries remain across and within sectors, we provide a “cheat attractively valued. Tech offers the most implied upside on relative forward P/E and sheet” that includes Price to Book (P/B), Price to P/OCF, and Energy remains inexpensive across all three relative metrics we track Operating Cash Flow (P/OCF), and Price to Fwd. (P/E, P/OCF, and P/B). Within Industrials and Materials, which both appear fairly Earnings (P/E) of each sector and industry. valued on relative forward P/E, Industrials Conglomerates, Airlines, Metals & Mining, and Paper & Forest products all offer implied upside vs. history. In contrast, the We present these as relative multiples (vs. the more domestically-oriented cyclicals (Consumer Discretionary and Financials) S&P 500), and calculate implied upside based on appear expensive across most of their industries, Media being the notable where the sector/industry trades relative to its exception. Health Care is the only defensive sector trading at a discount vs. all three historical average. We also provide charts of of its historical average relative multiples. sectors’ absolute and relative multiples over time. Chart of the month: the multiple swap As highlighted above, Chart 1 below shows the discount (premium) to history on relative forward P/E for the globally-oriented cyclical sectors of Industrials and See page 13 for a breakout of S&P Tech vs. the high-yielding defensive sectors of Telecom and Utilities, and how the stocks in each industry. premium/discount has changed over the past month. Chart 1: Discount (premium ) to history on relative forward P/E: Last month vs. now 40% 30% Apr-13 May-13 20% 10% 0% -10% -20% Discount (premium) to history to (premium) Discount -30% Industrials Tech Telecom Utilities Source: Compustat, BofA Merrill Lynch US Equity & US Quant Strategy c58da9b710df662c BofA Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 15 to 16. Link to Definitions on page 14. 11284392 Equity and Quant Strategy 11 June 2013 Relative valuation by sector Note: On the following pages, industries with less than 10 years of valuation data history are excluded. Boxes highlight sectors/industries with the highest implied upside and greatest implied downside. Implied upside is based on comparison between current relative multiple and historical average relative multiple. Table 1: Relative valuation (vs. S&P 500) by sector (based on data from 1986-5/31/13) Price to Book (Relative) Price to Operating Cash Flow (Relative) Forward P/E (Relative) Sector Current Average Implied upside Current Average Implied upside Current Average Implied upside S&P 500 (absolute metrics) 2.46 2.88 17% 10.42 10.36 -1% 14.24 15.10 6% Consumer Discretionary 1.67 1.00 -40% 1.25 0.91 -27% 1.20 1.08 -10% Consumer Staples 1.77 1.75 -1% 1.29 1.30 1% 1.14 1.11 -3% Energy 0.78 0.91 16% 0.68 0.76 12% 0.85 0.99 17% Financials 0.51 0.64 26% N/A N/A N/A 0.92 0.77 -16% Health Care 1.33 1.81 36% 1.36 1.73 28% 1.05 1.14 8% Industrials 1.27 1.04 -18% 1.08 0.99 -8% 1.02 1.01 -1% Information Technology 1.39 1.37 -1% 1.05 1.38 32% 0.93 1.23 32% Materials 1.12 0.87 -22% 1.03 0.89 -14% 0.98 0.99 1% Telecommunication Services 1.07 0.92 -14% 0.46 0.65 44% 1.22 1.05 -14% Utilities 0.65 0.60 -6% 0.62 0.64 5% 1.06 0.86 -19% *P/OCF excludes Financials Source: Compustat, First Call, BofA Merrill Lynch US Equity & US Quant Strategy Definitions of valuation metrics Price/Book: Month-end market cap divided by total common equity as of the most recent fiscal quarter Price/Operating Cash Flow: Month-end market cap divided by the last twelve months cash flow from operations as of the most recent fiscal quarter. Note: All industries’ multiples are relative to the S&P 500 ex. Financials for P/OCF. Forward Price/Earnings: Month-end market cap dividend by I/B/E/S consensus next twelve months earnings 2 Equity and Quant Strategy 11 June 2013 Consumer Discretionary Table 2: Relative Valuation (vs. S&P 500) for Consumer Discretionary industries (based on data from 1986-5/31/2013) Price to Book (Relative) Price to Operating Cash Flow (Relative) Forward P/E (Relative) Consumer Discretionary (# of co's) Current Average Implied upside Current Average Implied upside Current Average Implied upside Auto Components (4) 1.27 0.81 -36% 1.05 0.74 -30% 0.81 0.82 1% Automobiles (2) 1.53 0.87 -43% 0.92 0.26 -72% 0.77 0.73 -5% Distributors (1) 1.61 1.08 -33% 1.37 1.32 -4% 1.17 1.05 -11% Hotels Restaurants & Leisure (11) 2.05 1.28 -38% 1.24 1.13 -9% 1.30 1.17 -10% Household Durables (8) 1.07 0.78 -27% 3.13 1.03 -67% 1.06 0.89 -16% Internet & Catalog Retail (5) 4.93 2.88 -42% 2.50 2.57 3% 3.41 2.91 -15% Leisure Equipment & Products (2) 1.92 1.06 -45% 1.29 0.89 -31% 1.06 0.89 -16% Media (16) 1.25 0.87 -30% 1.05 1.19 13% 1.08 1.61 48% Multiline Retail (9) 1.23 1.00 -19% 1.01 1.07 6% 1.07 1.07 0% Specialty Retail (18) 2.17 1.31 -40% 1.29 1.36 6% 1.21 1.15 -5% Textiles Apparel & Luxury Goods (5) 1.93 1.02 -47% 1.60 1.24 -23% 1.24 0.93 -25% Source: Compustat, First Call, BofA Merrill Lynch US Equity & US Quant Strategy Chart 2: Consumer Discretionary P/B and Relative P/B, 1986-May 2013 1.8x 6.0x Current P/B: 4.1x 1.6x M in: 1.4x 5.0x Max: 5.0x 1.4x A vg: 2.7x 4.0x 1.2x 3.0x 1.0x 0.8x 2.0x 0.6x 1.0x 86 88 90 92 94 96 98 00 02 04 06 08 10 12 Consumer Discretionary Relativ e P/B (lhs) Consumer Discretionary P/B (rhs) Source: Compustat, BofA Merrill Lynch US Equity & US Quant Strategy Chart 3: Consumer Discretionary P/OCF and Relative P/OCF, 1986-May 2013 1.4x C urrent P /OC F : 13.0x 15.0x M in: 5.0x 1.2x M ax: 13.9x 13.0x A vg: 9.1x 1.0x 11.0x 0.8x 9.0x 0.6x 0.4x 7.0x 0.2x 5.0x 86 88 90 92 94 96 98 00 02 04 06 08 10 12 Consumer Discretionary Relativ e P/OCF (lhs) Consumer Discretionary P/OCF (rhs) Source: Compustat, BofA Merrill Lynch US Equity & US Quant Strategy Chart 4: Consumer Discretionary Fwd. P/E and Relative Fwd. P/E, 1986-May 2013 2.0x C urrent F wd. P /E: 17.1x 32.0x M in: 8.0x 1.8x M ax: 29.2x 28.0x A v g: 16.3x 1.6x 24.0x 1.4x 20.0x 1.2x 1.0x 16.0x 0.8x 12.0x 0.6x 8.0x 86 88 90 92 94 96 98 00 02 04 06 08 10 12 Consumer Discretionary Relativ e Fw d. P/E (lhs) Consumer Discretionary Fw d. P/E (rhs) Source: Compustat, First Call, BofA Merrill Lynch US Equity & US Quant Strategy 3 Equity and Quant Strategy 11 June 2013 Consumer Staples Table 3: Relative Valuation (vs.