- The S&P 500’s financials sector is the only one that did not see price-to-earnings multiple expansion during the past decade.
- Its relative cheapness presents investors with a unique buying opportunity, according to Savita Subramanian, Bank of America’s head of US equity and quantitative strategy.
- “We think financials’ re-rating may be in its early innings,” she told Business Insider via email.
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The stock-market sector at the heart of the 2008 crisis remains unloved among investors when judged by a key valuation measure.
The sector is none other than financials, which comprises of banks, insurers, and other institutions that helped trigger the worst economic meltdown in a generation.
There is no doubt that financials have delivered impressive returns overall, thanks in part to post-crisis regulatory reforms. Since the bull market began in March 2009, the sector has gained nearly 447%, ranking it in fourth position.
But narrowing in on the sector’s price-to-earnings multiple reveals that it has been uniquely undervalued over the past decade.
Savita Subramanian, Bank of America’s head of US equity and quantitative strategy, recently shared the chart below with Business Insider. It shows that only financials saw P/E contraction over the past decade. And in her view, it reflects an opportunity for investors to get in on the ground floor of a relatively cheap sector.
Ruobing Su/Business Insider
“We think financials’ re-rating may be in its early innings,” Subramanian told Business Insider via email.
In tandem with the valuation advantage, Subramanian identified three catalysts that should benefit financials moving forward.
1. More stable earnings
The fourth-quarter earnings season provided a snapshot of how far financials have come since 2008.
Shortly after banks kicked off their earnings reporting in January, Subramanian pointed out that the consensus forecast for financial profits was the highest on the S&P 500.
As of March 2, analysts’ expectation for 13.4% earnings growth from financials was bested only by utilities, data from Credit Suisse showed.
Subramanian also noted that the earnings results confirmed a solid consumer economy with no evidence of imminent credit risk — a far cry from the throes of the 2008 crisis.
2. A rotation into value
Much like the financials sector, value stocks that are beloved for their relatively cheapness have not been bid up to the stratosphere.
Throughout this bull market, there have been several breakouts in value stocks — including a sudden and violent rotation last July.
But Subramanian is among the strategists who see the record-low cheapness of value stocks relative to popular momentum names as an opportunity to buy.
And as this rotation to value occurs, financials should benefit.
3. Rising payout ratios with attractive cash returns
Companies that returned cash to shareholders via dividends earned a premium during the past decade, thanks to the scarcity of decent yields elsewhere.
Dividend payouts drove 64% of the S&P 500’s multiple expansion in the 10 years through mid-January, according to Subramanian.
Problem is, the spigot may not get wider: the S&P 500 had a payout ratio (dividends paid relative to net income) of 42% versus its long-term average of about 45%.
However, financial companies were stragglers when it came to cash returns. Their payout ratio of 27% was below the pre-crisis average level of 36%.
This means unlike the broader market, there is room for financial companies to raise their cash payments back towards the historical average.