Daily Spotlight: Values in Financials and Communication Services

Daily Spotlight: Values in Financials and Communication Services

Summary

Each month we take a close look at an aspect of sector investing. This month, we are examining growth and valuation. Investors hunting for stocks that reasonably balance long-term growth prospects and current value characteristics might want to look at companies in the Financial Services, Communication Services, and Healthcare sectors. These are among the industry groups that are currently selling for PEGY ratios — (price/earnings)/(growth+yield) — that are at or below the S&P 500’s ratio of 2.4. To generate the PEGY ratios, we use the P/E ratio for each sector based on forward earnings for the numerator. For the denominator, we average the growth rates for the past five years, along with two years of forward estimates — this in order to achieve a less-volatile earnings growth-rate trend. We then we add the current yield to approximate total return. As an example, the current S&P 500 P/E ratio is 20, the current yield is 1.6%, and the forecast five-year growth rate is 7.1%. The formula is 20/(1.6+7.1) = 2.4. Premium-valued sectors with low growth rates include Consumer Staples and Basic Materials. Based on our analysis of growth rates and valuations, along with other factors, we have established our current over-weight sectors as Technology, Financial Services, Consumer Discretionary, and Communication Services. Our under-weight sectors are Energy and Consumer Staples. Our Market-Weight sectors are Healthcare, Consumer Staples, Utilities, Real Estate, and Basic Materials.

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