S&P 500 Is Fully Valued

Nov. 15 2010 - 5:08 pm | 65 views | 0 recommendations |

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The risk/reward of the entire S&P 500 gets my “neu-tral” rat-ing.? My recently pub-lished Index Bench-mark report on the S&P 500 offers unique insights into the under-ly-ing prof-itabil-ity and val-u-a-tion of all the com-pa-nies com-prised by this index. It also offers bench-marks for investors con-sid-er-ing buy-ing ETFs or index funds based on the S&P 500 and for com-par-ing indi-vid-ual stocks to the index.

Our analy-sis of the index is based on the market-weighted aggre-ga-tion of data from our com-pany mod-els for the 481 com-pa-nies we cover in the S&P 500. Below is an overview of the five fac-tors that drive our Over-all Risk/Reward Rat-ing of Dan-ger-ous for this?index.

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1. Qual-ity of Earnings
   • Eco-nomic ver-sus reported earn-ings – Attractive/Positive Eco-nomic Earnings
   • Quin-tile Rank-ing for return on invested cap-i-tal (ROIC) – Very Attractive/1^st (best) Quintile
2. Val-u-a-tion
   • Free Cash Flow Yield – Attrac-tive at?3.3%
   • Price-to-economic book value – Attrac-tive at?1.3
   • Growth Appre-ci-a-tion Period – Dan-ger-ous at 20?years

Notably, Apple (AAPL) and Microsoft’s (MSFT) large mar-ket caps and extra-or-di-nar-ily high ROICs have a major impact on the market-weighted ROIC of the S&P 500. AAPL has an ROIC of 190.2% and is 2.6% of the S&P 500’s mar-ket value, rep-re-sent-ing 5% of the S&P 500’s ROIC. The next largest impact is from MSFT with an ROIC of 61.6% and as 2.1% of the S&P 500, it makes up 1.3% of the S&P 500’s ROIC. With-out AAPL and MSFT, the S&P 500’s market-weighted ROIC would fall from 17.4% to 11.1%. Click here for our report on MSFT and here for our report on AAPL.

Def-i-n-i-tions of the five fac-tors that drive our Risk Reward Rat-ings are?below:

1. Qual-ity of Earnings
2. Val-u-a-tion
   • Free Cash Flow Yield –? mea-sures the market-weighted aver-age of the free cash flow divided by enter-prise value for the com-pa-nies we cover in each?index
   • Price-to-economic book value –? mea-sures the market-weighted aver-age of stock price divided by the eco-nomic book value of the com-pa-nies we cover in each?index
   • Growth Appre-ci-a-tion Period – mea-sures the market-weighted aver-age of the market-implied growth appre-ci-a-tion period for the com-pa-nies we cover in each?index

Note that the indi-vid-ual com-pany mod-els used to per-form this analy-sis incor-po-rate key data from finan-cial foot-notes and the management’s discussion and analysis to reverse account-ing dis-tor-tion and pro-vide investors with the true eco-nomic earn-ings of businesses.

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