Best Bang for your P/E Buck

Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist

Wednesday, October 25, 2023

Good investments generally offer investors an opportunity to buy growth at an attractive price. Slower growth investments can work at lower prices, just as higher growth investments can work at higher prices. What you pay for the earnings (or dividend) stream matters, not just how fast those streams are flowing. Here we take a look at price-to-earnings ratios (P/E) by sector to see where the price of that growth may be most attractive.

Communication services valuations look attractive despite the mega-cap technology allocation

The accompanying figure compares P/Es to earnings growth using what is commonly called the PEG ratio (P/E divided by growth). For growth in the chart we use consensus earnings in 2024 over 2023. The first thing that jumps out is communication services looks like a good value at a PEG ratio of 0.9. Historically, anything below one is considered quite attractive. The sector trades at a 6% discount to the S&P 500 on 2024 estimates, reflecting 19% growth. That 19% growth rate may not be sustained for much more than a year or two, but investors looking ahead a year will see an attractive relative opportunity there if estimates are realized and artificial intelligence (AI) provides the boost many anticipate for Alphabet/Google (GOOG/L), Meta/Facebook (META), and others in the digital media space.

View enlarged chart

Warming up to communication services. LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains a neutral view on communication services but has warmed up to the sector in recent weeks on a combination of improving technical analysis trends, a solid earnings growth outlook (despite Google’s disappointing cloud results last night), and quite reasonable valuations. Well-received results from Netflix (NFLX), Verizon (VZ), and AT&T (T) have also been encouraging over the past week.

Healthcare also looks cheap on this metric. The healthcare sector, rated neutral by STAAC) has been a huge disappointment this year with its 4.9% year-to-date decline compared to the roughly 10% year-to-date gain in the S&P 500. Earnings season has been disappointing as the COVID-19 demand dissipates and some key drugs come off patent. But on a technical basis, the sector may be near a trough. As the economy slows over the next several quarters, the defensive characteristics of healthcare could become more attractive to market participants.

Energy is cheap on cash flows. Energy looks expensive through this lens but given the sector’s capital intensity, cash flow metrics that remove depreciation are better. On a cash flow basis, energy remains attractively valued in our view.

Real estate looks expensive. Similar to energy, real estate is more appropriately valued on cash flows (funds from operations, or FFO) excluding depreciation, but looks expensive to us given the risk of further deterioration in commercial real estate markets. It would not surprise us if real estate did not generate any earnings or cash flow growth in 2024.

Current Sector Views

LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) continues to favor the energy and industrials sectors and rates communication services neutral, but with a positive bias. On the flip side, STAAC suggest caution toward consumer staples and real estate and maintains negative views of those sectors


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