Thursday, November 14, 2013

Our latest valuation of S&P 500, while market is yelling: Yellen!

Given the equity market's two-day celebration of the near 'sure-thing' confirmation hearing of the even more dovish Janet Yellen, along with the same markets hitting new all-time highs, we thought to look ahead and try to value the equity market once more to see just how irrational the market has become.

Last time we did this was in mid-May '13 when S&P 500 was at 1633.70.  We took the median of our valuation range which included projected earnings of 2013 and of 2014.  This time we will only take 2014 into account as we are nearly done with Q3 '13 and are basically approaching the end of 2013.  But before we do that, let's take a look at where the S&P 500 EPS estimates (bottom-up operating estimates) were at before:

It is clear that two things have happened during the last six months: 1) so-called 'analysts' have reduced their EPS projections for this year and next by an average of 1.6%; and 2) 2014 EPS 1-year growth projection has been reduced by a mere 20bps.  Continuing reduction in EPS estimates has been going on for at least a couple of years!  To give you an idea, in Mar '12, 'analysts' expected 2013 EPS of $117.91, nearly 9% more than what they currently expect!  We must note one more thing that displays irrationality: the uber-optimism continues as while EPS projections keep getting 'adjusted' downwardly, estimate of EPS 5-yr CAGR goes up!  That figure has increased from 10.7% in May '13 to the current 11.4%.  But let's move on.

With these things in mind, let's look at the fair value we are giving to the market.  While we admit that we are not taking QE premium into account, we think this actually gives us an idea about what tapering can do, what a bind the Fed is finding itself in right now, and the bubble that is forming.  

This equity index covers a pretty broad market, so we look for our P/E to represent a PEG of 1.0.  Given that we can only work with the data we have, we are applying the 5-year EPS CAGR estimate plus current dividend yield to come up with our P/E ratio, which again represents a PEG (or PEGY) of 1.0.  We thought to at least partially address the ongoing irrationality, so we are taking two scenarios into account.  One is with the assumption of the original 10.7% CAGR (from 6 months ago), and the other is with the current 11.4%.

The first one gives us an earnings multiple of 12.8, resulting in a 1,544 valuation.  The second one gives us 13.5 and 1,628.  The median of the 1,544 and 1,628 range is 1,586, approx. 11% below where the market is currently.  And our range indicates a market overvalued between 9% and 14%.  We must again note that this guesswork is based on the historically uber-optimistic Wall Street 'analysts' EPS and EPS growth estimates.  

Lastly, BCOR which we are no longer bullish on is down about 70bps, IACI is up 1.25% and nearing our $59.50 valuation, FB is up 62bps, TWTR got a nice dead-cat bounce yesterday and is up 4.2% today, and AVID hit its 52-week high of $8.23 today, currently up 2%. 

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