Since bottoming at a low of around 0.25 at the beginning of 2015, the valuation dispersion of S&P 500 stocks has steadily risen and is now trading at the highest level since the financial crisis, according to research from Bank of America Merrill Lynch.
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In a research report published at the end of last week, Bank of America's equity and quant strategy team, present data showing that despite the fact the S&P 500 is expensive compared to its history, there are more stock selection opportunities for value investors today than at any other point since the financial crisis. Specifically, by the end of February, the S&P 500 forward P/E had fallen to 17, the lowest level since late 2016 and only 11% above its long-term average. Meanwhile, the forward P/E dispersion of S&P 500 stocks has risen to around 0.4, significantly above the long-term median of approximately 0.32. This dispersion suggests a " wide array of opportunities to differentiate between cheap and expensive stocks" as the report sums up.
The difference between the valuation of various sectors in the index is quite significant. Based on data between 1986 and the end of February 2018, the most expensive sector on a forward P/E basis relative to its historical average is the Diversified Financial Services sector, closely followed by the Internet and Direct Marketing retail sector. Diversified Financial Services is trading at a relative forward P/E of 1.33 compared to its historical average of 0.8 implying a mean reversion downside of 40%.
Meanwhile, the Internet and Direct Marketing retail sector is trading at a relative forward P/E of 5.2, compared to its long-term average of 3.1, implying a mean reversion downside of 41%. The cheapest sectors appear to be Automobiles and Airlines. However, within the Consumer Discretionary industry as a whole, 9 out of 12 sectors are trading at a discount to their long-term average valuation on a forward P/E basis. The most undervalued is Automobiles followed by Media and then Diversified Consumer Services.
The cheapest industry on a forward P/E basis is Telecommunication Services followed by Healthcare, both of which are trading at a discount to long-term average valuations. The most expensive industry by far is Consumer Discretionary, although as noted above, some sectors are significantly cheaper than others on a historical basis.
