2023-12-19 08:00:00 ET
Summary
- The materials sector is close to 11-year averages in value and quality metrics.
- The construction materials industry is undervalued, whereas mining and metals are overvalued.
- Fast facts on Materials Select Sector SPDR® Fund ETF.
- Two stocks cheaper than their peers in December 2023.
This monthly article series shows a dashboard with aggregate industry metrics in materials. It is also a top-down analysis of sector ETFs like the Materials Select Sector SPDR® Fund ETF (XLB), whose holdings are used to calculate these metrics.
Shortcut
The next two paragraphs in italic 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 for each industry: Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. 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 or non-available when the "something" is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).
I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.
Value and Quality Scores
I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for packaging in the table below is the 11-year average of the median Earnings Yield in packaging companies.
The Value Score ("VS") is defined as the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). The same way, the Quality Score ("QS") is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).
The scores are in percentage points. 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.
Current Data
The next table shows the metrics and scores as of last week's closing. Columns stand for all the data named and defined above.
VS | QS | EY | SY | FY | ROE | GM | EYh | SYh | FYh | ROEh | GMh | RetM | RetY | |
Chemicals | -0.52 | -8.05 | 0.0391 | 0.5391 | 0.0176 | 16.11 | 39.81 | 0.0429 | 0.4486 | 0.0202 | 17.90 | 42.41 | 7.40% | -1.16% |
Constr. Materials | 24.35 | 33.04 | 0.0433 | 0.6970 | 0.0672 | 19.34 | 34.47 | 0.0398 | 0.8196 | 0.0375 | 12.92 | 29.60 | 17.61% | 40.24% |
Packaging | -2.14 | 5.83 | 0.0553 | 1.1868 | 0.0249 | 19.44 | 26.32 | 0.0492 | 1.0558 | 0.0362 | 18.19 | 25.11 | 6.86% | 8.98% |
Mining/Metals | -44.42 | -3.02 | 0.0357 | 0.9511 | 0.0004 | 8.01 | 22.95 | 0.0424 | 1.1755 | 0.0245 | 9.39 | 21.12 | 9.87% | 8.14% |
Value and Quality Chart
The next chart plots the Value and Quality Scores by industry (higher is better).
Evolution Since Last Month
The value score has deteriorated in all subsectors due to the recent market rally.
Momentum
The next chart plots median returns in subsectors.
Interpretation
The materials sector is close to 11-year averages regarding valuation and quality metrics, as reported in my S&P 500 monthly dashboard . The construction materials industry has by far the best value and quality scores in the sector. Packaging and chemicals are close to their historical baseline for both value and quality. Mining/metals is overvalued by over 40% relative to the baseline.
Fast Facts on XLB
The Materials Select Sector SPDR® Fund ETF started investing operations on 12/16/1998 and tracks the Materials Select Sector Index, which is capital-weighted. It has 28 holdings, a total expense ratio of 0.10% and a trailing 12-month distribution yield of 1.91%. The fund is overweight in the chemical industry, which represents 67.2% of asset value.
The next table lists the top 10 holdings with fundamental ratios and dividend yields. The portfolio is very concentrated: they represent 65.7% of asset value and the heaviest constituent weighs 20.5% (Linde plc).
Ticker | Name | Weight% | EPS growth %TTM | P/E TTM | P/E fwd | Yield% |
Linde plc | 20.51 | 60.12 | 33.66 | 28.94 | 1.25 | |
The Sherwin-Williams Co. | 7.57 | 26.06 | 33.19 | 30.03 | 0.78 | |
Air Products and Chemicals, Inc. | 6.25 | 2.10 | 26.31 | 20.92 | 2.58 | |
Freeport-McMoRan, Inc. | 6.18 | -43.62 | 27.95 | 27.05 | 1.45 | |
Ecolab, Inc. | 5.17 | 9.60 | 45.75 | 37.84 | 1.16 | |
Newmont Corp. | 4.49 | -181.30 | N/A | 25.32 | 3.91 | |
Nucor Corp. | 4.45 | -38.02 | 8.76 | 9.64 | 1.25 | |
Dow, Inc. | 3.98 | -76.37 | 29.75 | 24.50 | 5.16 | |
PPG Industries, Inc. | 3.67 | 32.34 | 24.87 | 19.48 | 1.75 | |
Corteva, Inc. | 3.43 | -30.08 | 35.78 | 17.87 | 1.37 |
Ratios: Portfolio123.
Since January 1999, XLB has outperformed the S&P 500 ( SP500 ). However, the difference in annualized return is only 49 bps. Volatility is quite high, resulting in a slightly inferior risk-adjusted performance (reported as Sharpe ratio in the next table).
Total return | Annualized return | Max Drawdown | Sharpe ratio | Volatility | |
XLB | 570.41% | 7.92% | -59.83% | 0.38 | 21.20% |
S&P 500 | 497.35% | 7.43% | -55.19% | 0.41 | 15.39% |
In 2023 to date, XLB has lagged the broad index by 12% in total return:
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In summary, Materials Select Sector SPDR® Fund ETF provides capital-weighted exposure to the materials sector. It is overweight in chemical companies and in its top holdings. Investors who are concerned by risks related to portfolio concentration may prefer the Invesco S&P 500® Equal Weight Materials ETF ( RSPM ).
Dashboard List
I use the first table 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 us that a chemical company with an Earnings Yield above 0.0391 (or price/earnings below 25.58) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The stocks below are part of the list sent to subscribers several weeks ago, based on data available at this time.
Veritiv Corp. | |
Graphic Packaging Holding Co. |
It is a rotational model with a statistical bias toward excess returns on the long term, not the result of an analysis of each stock.
For further details see:
XLB: Materials Dashboard For December