Sector Valuation: Shiller P/E by Sectors

Prof. Robert Shiller of Yale University invented the Schiller P/E to measure the market's valuation. The Schiller P/E is a more reasonable market valuation indicator than the P/E ratio because it eliminates fluctuation of the ratio caused by the variation of profit margins during business cycles. Members can access to the Shiller P/E for S&P 500 companies by click here.

GuruFocus Shiller P/E page gives us an idea on where we are with general market valuations. But the market is rarely balanced. Some sectors are more undervalued than the others. With this page we present the Shiller P/E for different sectors. You will be able to see which sectors are more undervalued than the others.

The 500 companies can be divided into 11 sectors. Each sector contains different number of companies.

Download Historical Data

The following are the Shiller P/E and regular P/E charts by sectors:

We can observe that Energy sector has the lowest Shiller P/E of around 15, which is really low compared to that of S&P 500. The Shiller P/E for Industrials, Financial Services, Consumer Defensive, and Utilities sectors are around 20, a little bit lower than that of S&P 500. For Basic Materials, Healthcare, and Technology sectors, their Shiller P/E is around 24, about the same level of S&P 500. Consumer Cyclical and Communication Service have higher Shiller P/E at around 35, while Real Estate has the highest Shiller P/E at above 50. Usually the Shiller P/E is higher than the regular P/E, yet for Utilities, it is opposite. This is probably because the earnings for Utilities sector shrank a lot for the last ten years. Energy sector is undervalued while Real Estate sector is highly overvalued. Consumer Cyclical and Communication Service sectors are slightly overvalued.

How Is the Shiller P/E by Sectors Calculated?

1. For each sector, use the quarterly net income of the companies over the past 10 years.

2. Adjust the past net income for inflation using CPI; past net income are adjusted to today's dollars.

3. Average the adjusted values for E10

4. For each sector, use the quarterly market capitalizations of the companies.

5. Adjust the past market capitalizations for inflation using CPI; past market capitalizations are adjusted to today's dollars.

6. The past Shiller P/E equals to the ratio of the adjusted market capitalizations over E10.

7. Current Shill P/E ratios equals to the ratio of the total market cap of the companies within each sector divided by the total inflation adjusted net income.

Note: From 03/31/2010 to 06/27/2013, we calculate the historical quarterly Shiller P/E by sectors. We assume the historical S&P 500 companies stay the same with the S&P 500 companies on 06/27/2013. After that time point, the Shiller P/E we calculate will use the current S&P 500 companies, and it will be updated daily.

Why Is the Regular P/E Ratio Deceiving?

The regular P/E uses the ratio of the S&P 500 index over the trailing-12-month earnings of S&P 500 companies. During economic expansions, companies have high profit margins and earnings. The P/E ratio then becomes artificially low due to higher earnings. During recessions, profit margins are low and earnings are low. Then the regular P/E ratio becomes higher. It is most obvious in the chart below:

The highest peak for the regular P/E was 123 in the first quarter of 2009. By then the S&P 500 had crashed more than 50% from its peak in 2007. The P/E was high because earnings were depressed. With the P/E at 123 in the first quarter of 2009, much higher than the historical mean of 15, it was the best time in recent history to buy stocks. On the other hand, the Shiller P/E was at 13.3, its lowest level in decades, correctly indicating a better time to buy stocks.

Investment Strategies at Different Market Levels

The Shiller P/E and the ratio of total market cap over GDP can serve as good guidance for investors in deciding their investment strategies at different market valuations. Historical market returns prove that when the market is fair or overvalued, it pays to be defensive. Companies with high quality business and strong balance sheet will provide better returns in this environment. When the market is cheap, beaten down companies with strong balance sheets can provide outsized returns.

To summarize:

1. When the market is fair valued or overvalued, buy high-quality companies such as those in the Buffett-Munger Screener.

2. When the market is undervalued, buy low-risk beaten-down companies like those in the Ben Graham Net-Net Screener. Buy a basket of them and be diversified.

3. If market is way over valued, stay in cash. You may consider hedging or short.