As we continue to see the overall negative effects of “special charges”, currency exchange rates, and low oil prices on earnings during the fourth quarter, Goldman Sachs today released a “US Thematic Views” report that shows that S&P 500 return on equity remained at 16.3% during the third quarter 2014, for the second consecutive quarter. Goldman Sachs highlights that excluding the financial sector, return on equity (ROE) stands at 19.1%.  While margin expansion was decent, the gains were offset due to increase tax bills and cut backs to leverage.

S&P 500
Goldman Sachs: US Thematic Views

Only 4 out of 10 sectors posted ROE increases

Of the ten sectors, only four managed to post gains in ROE, which was led by the telecoms sector.  This has given telecoms the highest ROE of any sector at 26%, a rise of 96 basis points.  The gains for telecom come mostly from Verizon and AT&T, which both saw margin increases and Verizon’s leverage boost.  However, Goldman Sachs says that ROE for telecoms sector will likely decrease in the fourth quarter 2014, which will be confirmed once the report is released.  The materials sector increased 50 basis points to 17.1% ROE, energy saw their overall ROE increase by 39 basis points to 13.5%, and utilities was the last ROE gainer of 9 basis points to bring the sector total to 10.7%.

S&P 500
Goldman Sachs: US Thematic Views

 

6 sectors that lost ROE mostly due to leverage and taxes

Information technology saw the largest decrease in ROE by -28 basis points to 21.6%, due to heavy tax bills mostly, which decreased ROE by -49 basis points. Additionally, turnover hit IT hard with -27 basis points.  Consumer discretionary sector lost -26 basis points to 22.3% ROE, due to -20 basis points from taxes and -18 basis points in margin losses.   Health care decreased -15 basis points to 19.2%, mostly due to -35 basis points from taxes. Consumer staples lost -7 basis points to 25.1%, due to margin losses of -12 basis points. Industrials lost -7 basis points to 20.2%, from a -35 basis point decrease in leverage. The financial sector lost only -1 basis point to 10.4%, thanks to -17 basis points from taxes, -22 basis points from leverage and -19 basis points from borrow costs.  However, financials were able to recover most of the ROE losses with gains from margin and turnover.

S&P 500
Goldman Sachs: US Thematic Views

Overall, while the S&P 500 did not see a change in ROE at 16.3%, book value per share of the index reached $715, which gives the index a price to book of 2.80.  Goldman Sachs maintains that this is within historical average range, in which when ROE ranges from 16%-17%, price to book ratios range from 2.5-3.0.  Goldman goes further by explaining that ROE tends to be a better barometer than book values for valuation.  This is due mostly to the fact that investors tend to “reward superior profitability with higher valuation”.  Ultimately, fourth quarter figures for ROE could be a bit more skewed due to oil’s fall and other charges that we are seeing from 4Q earnings right now.

S&P 500 EBIT Margins

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