In addition to regularly rebalancing client portfolios, we analyze future price-to-earnings ratios (called “forward P/E ratios”) monthly to overweight sectors where earnings appear cheap and underweight those where earnings appear expensive based on historical valuations. This strategy of tilting towards cheaper funds and away from expensive ones we call Dynamic Tilt.

The calculation of a price-to-earnings ratio is very simple. The current price per share of the security in the market is divided by the reported earnings per share of the underlying company or companies. In forward P/E ratios, the earnings is the forecasted next 12-months of earnings.

Because P/E is price divided by earnings, the forward P/E score can be thought of as how many dollars you need to pay in order to purchase an expected $1 of earnings over the next twelve months. A high forward P/E means you are paying more for those earnings. A low forward P/E means that you are paying less for those earnings.

Now, there is more to picking a good sector than just its cheapness. The cheapest produce in the grocery store today may be turnips, but that’s not a great purchase when you are trying to make a fruit salad. Some sectors behave differently than others, like Consumer Staples and Technology. For this reason, we like to compare the current forward P/E ratio to the historical average forward P/E ratios for the same sector.

This quarter, when we compare the September 30, 2022 forward P/Es for all the sectors we track, we see that almost every sector is either fairly valued or undervalued.

In U.S. Stocks, large cap, mid cap value, and small cap value all appeared undervalued compared to historical averages.

	Sept 30, 2022 forward P/E	Interpretation
U.S. Large Cap	15.91	LOW
U.S. Mid Cap Value	11.10	LOW
U.S. Small Cap Value	10.72	LOW
U.S. Technology	19.00	FAIR
U.S. Healthcare	18.12	FAIR
U.S. Consumer Staples	18.33	FAIR

 

In Foreign Stocks, Austria, Canada, Chile, Norway, and United Kingdom appeared the most undervalued compared to historical averages.

	Sept 30, 2022 forward P/E	Interpretation
Australia	12.46	FAIR
Austria	6.19	LOW
Canada	10.65	LOW
Chile	7.56	LOW
Denmark	17.34	FAIR
Emerging Markets	10.20	FAIR
Finland	13.69	FAIR
Ireland	11.81	FAIR
Korea, South	7.83	FAIR
Netherlands	15.64	FAIR
New Zealand	23.91	FAIR
Norway	7.32	LOW
Singapore	14.78	FAIR
Sweden	13.53	FAIR
Switzerland	14.93	FAIR
Taiwan	10.10	FAIR
United Kingdom	8.62	LOW

 

This undervaluation of U.S. and foreign stocks can be thought of stocks being on sale.

As David Marotta describes in his 2008 article “When Will The Markets Stop Dropping?,” it is a good time to buy when it seems like every other house is having a yard sale. Meanwhile, selling your assets just because your neighbor is having a sale is a foolish move. The same is true in the markets.

Stocks are on sale; there is no reason for you to sell right now.

Photo by Markus Spiske on Unsplash