Thursday, March 15, 2018

Improved Earnings Growth Expectations Broadly Reduce PEG Ratios

Before passage of The Tax Cuts and Jobs Act in December, earnings growth for the S&P 500 was expected to be low double digits in calendar year 2018. Since passage of tax reform, a significant improvement in earnings growth expectations has occurred. The below table shows I/B/E/S earnings growth expectations in October by sector and for the S&P 500 Index compared to expectations as of the end of last week.

Every sector except utilities and real estate have seen significant increases in earnings growth expectations. For some sectors the growth rate has more than double, e.g., telecommunications, energy, financials and industrials sectors. Additionally, the valuation of some sectors has improved fairly significantly.

What has seen marked improvement too is the PEG ratio or P/E to earnings growth ratio. I have written a few articles covering the PEG ratio and include a reference to the CFA Institute's Inside Investing blog and the article, Is It Overvalued? Look at the PEG Ratio. Readers wanting more insight into the PEG ratio should read the CFA Institute article as well as my post, A Look At The PEG Ratio: Earnings Growth Versus Valuation.

Continuing though, as the below chart shows, five sectors in the S&P 500 Index are trading with PEG ratios below 1.0, even the S&P 500 Index itself has a PEG less than 1.0. When I wrote the article, Equity Valuations No Longer Matter?, in July of last year, only one sector had a PEG ratio less than 1.0 and that was the energy sector.

The CFA Institute article referenced above appropriately notes the PEG ratio is not "the 'be all and end all' measure, but it does provide a quick and dirty yardstick for identifying potentially under- or overvalued securities." When only looking at earnings growth, vis-à-vis valuations or the P/E ratio, stocks broadly appear more attractive today than they did as recently as mid year last year.

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