Searching For Value In Large-Cap Stocks by Randall Abramson, CFA, Trapeze Asset Management
U.S. Value Is Scarce
Finding compelling undervalued large-cap stocks in the U.S. is currently a tough task. With a trailing 12 month P/E ratio of 19x, the S&P 500 is hardly a bargain. Large cap U.S. stocks also appear to be expensive through the lens of our proprietary valuation model, TVMTM. The average price-to-TVMTM for the constituents that comprise the S&P 500 now stands at 116%.
Mega caps are less expensive but still close to fair value. For example, Table 1 lists the current trailing 12-month P/E ratios and P/TVMTM values for the ten highest weighted stocks in the S&P 500. As a group they are cheaper than the overall S&P 500 but still not attractive. Similarly, the Dow Jones Industrial Average currently trades right at its TVMTM value (Figure 1). In fact, since June 2013 it has meandered tightly around its TVMTM value.
Return Outlook Muted
With no discount to fair value, the expected return for U.S. large-caps is simply the expected future growth in fair market value. For the Dow stocks, this has been approximately 7% annualized over the last 5 years. Going forward, we expect an annual growth rate closer to GDP at 3-4%. Value Line’s expected 5 year return for the average stock sits near a multi-year low.
The few names that do appear on our radar screen are either in sectors experiencing considerable headwinds (e.g., Energy, Materials and Financials) or have negative analyst earnings estimate revisions (e.g., McDonald’s, Owens-Illinois), which our research has shown to be the best value trap predictor.
With the return outlook muted, we are content to hold cash while we wait for new opportunities to arise. Meanwhile, we expect our current undervalued holdings to ascend to fair market value over the next 12-24 months.