Stocks Hit By Valuation Compression In 2022

stocks-hit-by-valuation-compression-in-2022

Stock trader Peter Tuchman works on the floor of the New York Stock Exchange (NYSE). (Photo by … [+] Spencer Platt/Getty Images)

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The equity markets had a horrible 2022 with the Dow, S&P 500 and Nasdaq down 8.8%, 19.4% and 33.1%, respectively. This isn’t surprising as investors faced increased interest rates, a potential recession leading to reduced earnings, Russia invading Ukraine and inflation spiking to levels not seen in decades.

To help understand what led to such significant declines it is interesting to use a simple equation to determine what factors led to most stocks enduring a bear market.

Using the P/E equation

Price to Earnings or a company’s P/E ratio is probably the most common valuation metric used to determine if a company’s shares are under, equally or over-valued (which is also a judgment call). The equation can also be used to calculate what price or value an investor believes the stock or Index should be by estimating earnings and giving a multiple to what the earnings are worth.

This equation can be used to determine which of the two inputs, earnings or valuation multiple, had the most impact on a stock price or Index. Since the S&P 500 Index is the broadest of the three most commonly followed this is what occurred during 2022. The Index’s earnings estimates are from John Butters, FactSet’s Vice President Senior Earnings Analyst.

Start of 2022

  • Index: 4,766
  • Earnings estimate: $223.50
  • P/E multiple: 21.3x

End of 2022

  • Index: 3,840
  • Earnings estimate: $220.87
  • P/E multiple: 17.4x

Year changes

  • Index: down 19.4%
  • Earnings estimate: down 1.2%
  • P/E multiple: down 18.5%

While the earnings for the S&P 500 companies only fell 1.2%, the value investors were willing to pay for future earnings accounted for 95% of the Index’s decline by falling 18.5%.

S&P 500 forward 12-month P:E multiple

John Butters, FactSet

The red circle denotes the beginning of 2022.

Energy earnings add a wrinkle

Butters writes a weekly report detailing the S&P 500 earnings. In his most recent one dated December 15 he wrote, “Most of the (year-over-year) earnings growth for 2022 occurred in the first half of the year. For the first and second quarters the S&P 500 reported earnings growth of 9.4% and 5.8%, respectively. However, the index reported earnings growth of 2.5% for the third quarter and is projected to report an earnings decline of -2.8% for the fourth.”

He added, “The Energy sector is expected to report the highest (year-over-year) earnings growth of all eleven sectors at 151.7%. It is also expected to be the largest contributor to earnings growth for the S&P 500 for 2022. If this sector was excluded, the index would be expected to report a decline in earnings of -1.8% rather than growth in earnings of 5.1%.”

Using the same analysis as before, these are the calculations for the earnings and P/E multiple impact to the S&P 500 when the Energy sector earnings are removed.

Start of 2022

  • Index: 4,766
  • Earnings estimate: $223.50
  • P/E multiple: 21.3x

End of 2022

  • Index: 3,840
  • Earnings estimate: $204.74 (1.8% lower than 2021’s earnings of $208.49)
  • P/E multiple: 18.8x

Year changes

  • Index: down 19.4%
  • Earnings estimate: down 8.4%
  • P/E multiple: down 12.1%

Removing the positive impact from the Energy sector’s earnings, the decline in the S&P 500 Index isn’t as nearly as skewed to just a valuation compression.

S&P 500 earnings estimates for 2022 and 2023. Includes 2022 estimate without the Energy sector

John Butters, FactSet

The red circle denotes 2022 earnings without the Energy sector.

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