The Stock Market Is Presenting An Investment Opportunity We Haven’t Seen In At Least 25 Years

Goldman Sachs chief U.S. equity strategist  David Kostin flags an interesting development in the stock market in 2013: the  dispersion of individual stocks’ price-to-earnings ratios has fallen to the  lowest level in at least 25 years. In other words, as Kostin puts it in a note to clients, stocks with different  growth forecasts are now valued at similar multiples.


P/E dispersion in the stock market

Source: Compustat, I/B/E/S, and Goldman Sachs Global Investment  Research

How did that happen?

“Investor demand for ‘value’ has been pervasive,” says Kostin. “Low  valuation stocks have outperformed higher valuation peers by 12% in 2013 on a  sector-neutral and equal weight basis.” Kostin writes that the low dispersion of valuation multiples in the market has created attractive trading opportunities:

As a result, the distribution of S&P  500 P/E multiples is now its tightest in at least 25 years, implying less  differentiation of companies based on valuation. With valuation clustered  together we believe there are attractive relative value opportunities where  companies with different fundamentals are trading at very similar valuation  levels.

Sector valuations are also compressed. We  estimate that nine of the ten S&P 500 sectors have P/E dispersions below  their respective 30-year averages with Utilities, Industrials, and Consumer  Staples showing more valuation compression than the S&P 500 itself. Only  Financials stock valuations are more spread out than their average since  1980.

We  screened the S&P 500 for subsector peers where (1) P/E valuation is +/-5% of  one another; (2) 2014 EPS growth forecasts differ by at least 25%; and (3) our  Growth MEF scores show significantly different underlying growth metrics. That  approach identifies 20 relative value opportunities for stock-pickers, as shown  in Exhibit 1. Recent history shows that P/E dispersion and the performance of  low vs. high valuation stocks have been closely related since the financial  crisis. As investors shift from a policy- and valuation- based framework to a  focus on growth we expect these anomalies to moderate. Below are the relative-value opportunities identified by  Goldman.

relative value trades

Compustat, FirstCall, I/B/E/S, and Goldman Sachs Global  Investment Research



Disclosure: This communication is for informational purposes only and nothing herein should be construed as a solicitation, recommendation or an offer to buy or sell any securities or product, and does not constitute legal or tax advice. The information contained herein has been obtained from sources believed to be reliable but we do not guarantee accuracy or completeness. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional investment, legal, tax, or accounting counsel.




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