Authored by Michael Lebowitz via RealInvestmentAdvice.com,
“Value is back in vogue”, the media claim. Investors are rushing out of the high-flying mega-cap tech stocks and into the boring staples, utilities, and healthcare stocks. Given the huge outperformance of value stocks versus growth stocks, it appears investors are going all in on the value rotation.What some of these investors don’t know is that they are not necessarily buying value but could, in fact, be selling it.
Before turning your investment perspective upside down, let’s define how most investors think about value and growth stocks. Commonly, investors refer to value stocks as those whose shares trade at a low price relative to their earnings and earnings potential. Growth stocks are those whose earnings are expected to grow faster than the market average.
For some reason, investors often assume that growth and value are mutually exclusive. They are not, as we will explain.
TheFinVizwebsite offers a great perspective on valuations across the S&P 500. Their heat map below shows the P/E ratio for every S&P 500 stock. The “E” is based on the trailing twelve months of earnings. The box sizes are commensurate with each market cap. This layout provides a unique way to view and compare valuations by stock, sector, and market cap.
As the map shows, many companies, large and small, across most sectors, have expensive P/E ratios of 30 or higher. Conversely, there are very few green boxes with more reasonable P/E ratios.
The P/E ratios shown above are a good indicator of a stock’s current price relative to its earnings over the last 12 months. There is a benefit to tracking trailing earnings-based valuations;however, we must keep in mind that investors are buying tomorrow’s earnings, not yesterday’s.
Thus, the forward P/E ratio should be considered alongside the more traditional trailing P/E.
The heat map below shows forward P/Es. The “E” in these calculations is based on forward one-year earnings estimates. The graphic still shows many red boxes, but fewer are bright red, and more are neutral or green.Forward P/E ratios are not as stretched as trailing P/E ratios.
Before moving on to a third type of P/E analysis, it’s worth recalling Benjamin Graham’s logic. Graham was an economist and professional investor, best known for his bookSecurity AnalysisandThe Intelligent Investor.He is commonly referred to as the father of value investing. His conservative, fundamentals-based approach has guided many successful investors, including Warren Buffett. In fact, Buffett once said:
Source: ZeroHedge News
