SPY - RSP: S&P 500 Dashboard For December

2023-12-01 14:07:39 ET

Summary

• The energy, financials, and real estate sectors have attractive value and quality scores.
• Technology and industrials are overvalued by more than 20% relative to the historical baseline.
• The stock market has been significantly skewed by mega-cap companies in 2023, so we take a look at Invesco S&P 500® Equal Weight ETF.

This monthly article series reports sector metrics in the S&P 500 Index (SP500). It is also a top-down analysis of all exchange-traded funds, or ETFs, based on the S&P 500.

Fast Facts on RSP

Invesco S&P 500® Equal Weight ETF ( RSP ) holds all S&P 500 stocks in an equal-weight portfolio rebalanced quarterly. RSP is expected to outperform the S&P 500 in the long term by playing the size factor (smaller companies have a higher weight than in the capital-weighted index) and the rebalancing mechanism (which is a "sell high, buy low" implicit strategy). In fact, the equal-weight S&P 500 has beaten the capital-weighted index by 1.8% in annualized return since 1999, and by only 0.6% since RSP inception (04/24/2003). RSP has lagged in the last 5 years, especially in 2023 as reported by the charts below. The expense ratio is a bit higher than for the SPDR® S&P 500 ETF Trust ( SPY ): 0.20% vs. 0.09%.

Shortcut

The next two paragraphs in italics describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios in every sector: Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). All are calculated on trailing 12 months. For all these ratios, higher is better, and negative is bad. EY, SY, and FY are medians of the inverse of Price/Earnings, Price/Sales, and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable when the "something" is close to zero or negative (for example, companies with negative earnings). I also calculate two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians rather than averages because a median splits a set in a good half and a bad half. Capital-weighted averages are skewed by extreme values and the largest companies. As a consequence, these metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

Historical baselines are calculated as the averages on a look-back period of 11 years for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh. For example, the value of EYh for technology in the table below is the 11-year average of the median Earnings Yield of S&P 500 tech companies.

The Value Score "VS" is the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). In the same way, the Quality Score "QS" is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the three valuation metrics are of equal importance, except in energy and utilities, where the Free Cash Flow Yield is ignored to avoid some inconsistencies. VS and QS are capped between -100 and +100 when the calculation goes beyond th ese value s .

Current Data

The next table shows the metrics and scores as of the last daily closing. Columns stand for all the data defined above.

Score Charts

The next chart plots the Value and Quality Scores by sector (higher is better).

Score variation since last month:

The next chart plots momentum scores based on median returns by sector.

Interpretation

A hypothetical S&P 500 "median" company is overvalued by 7.7% relative to average valuation metrics since 2012. The quality score is slightly above the historical baseline. We can translate median yields in their inverse ratios:

Price/Earnings: 24.45 - Price/Sales: 2.55 - Price/Free Cash Flow: 39.37

Energy has the most attractive value and quality scores of GICS sectors. It has been so since February 2022 . Real estate and financials are undervalued by more than 20% relative to 11-year averages, and they also have good quality scores, especially financials. Fundamental ratios are less reliable in these two sectors, but comparing aggregate metrics to their own historical averages makes sense. Materials, utilities, communication, healthcare, consumer staples, and consumer discretionary are close to their historical baseline in valuation. Among them, materials, healthcare, and consumer staples are slightly below it in quality. Technology and industrials have good quality scores, but it doesn't justify overvaluations of 25% and 22%, respectively.

SPY has gained 13.80% in 12 months (total return), whereas the median return of the S&P 500 is +3.37% (reported above in the table) and the equal-weight return (measured on RSP) is +1.29%. It means benchmarks have been significantly skewed to the upside by mega-cap companies.

We use the table above to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells that a large consumer staples company with an Earnings Yield above 0.0425 (or price/earnings below 23.53) is in the better half of the sector regarding this metric. A Dashboard List is sent every month to our subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time.

For further details see: