Analysts at Goldman Sachs Group, Inc. (NYSE:GS) reported that the distribution of valuation reached its lowest level in 25 years and below average in eight to ten sectors. They noted that single stock valuations are more tightly distributed than any time over the past 25 years.
Also see: A Look at Current S&P 500 Valuation By Sector
Dramatic increase in valuation factor
Goldman Sachs analysts David Kostin and Stuart Kaiser along with their colleagues Amanda Sneider, Ben Snider and Rima Reddy said that last year, their valuation factor increased dramatically in terms of return perspective as the distribution of P/E multiples compressed.
Based on their Micro Equity Factor (MEF), the performance of S&P 500 stocks were relative with lowest compared with highest valuation on a sector-neutral basis. They noted that low valuation stocks increased by more than 20% over the past 12 months.
Kostin, Kaiser and their fellow analysts recommended that investors should focus selecting stocks in the utilities, consumer discretionary, and industrials sectors. They emphasized that these sectors valuation dispersion are below the 30-year average.
Valuation distribution for the S&P 500
The analysts said the current valuation distribution for the S&P 500 (INDEXSP:.INX) is a 1.5 standard deviation below that 30-year average, and lower than 8 to 9 sectors, excluding the Financials sector, with above average valuation distribution because of rising interest rates and a steep yield curb that helps banks and insurers, but hurts other sectors such as REITs. The dispersion of valuation in the energy sector is in line with historical averages.
Goldman Sachs analysts pointed out that the logical strategy for investors is to purchase stocks at faster growth at little or no premium given the fact that equities are trading in tight P/E multiple bands within a sector.
As an example, the analysts explained that Eaton Corporation (NYSE:ETN) and Rockwell Collins, Inc. (NYSE:COL) are trading with forward P/Es at 15.2x and 15x after YTD gains of 27% and 22%, respectively. According to them, the estimated sales and EPS growth for ETN is higher at 6% and 19%, respectively compared with the 2% sales growth and 8% sales growth for COL. Both stocks belong to the industrials sector. The analysts noted that the return to Goldman Sachs Group, Inc. (NYSE:GS) equity based on their price targets indicated a gap of 25%. According to them, the situation is the same in the utilities and discretionary sectors.
According to the analysts, the macro data showed that the economy of the United States is growing modestly, but it is sufficient to drive equities higher.