RevenueShares: Valuation Risk: From Micro to Macro

ETF Trends

One of the reasons RevenueShares Indexes are included in the “smart beta” category of indexes is based on our methodology’s adherence to reducing excessive exposure to lofty valuations. In the case of equities, valuation risk is the risk that a stock is overvalued and will fetch less than expected when it is sold by the person who holds it. Going forward, we believe the price to sales metric is superior to looking at the price to earnings of a company or fund when attempting to view the relative value of a company or index. With the increased interest in stock buybacks currently being undertaken by companies and the focus on cost cutting initiatives following the Great Recession, the net earnings of many companies have been fully optimized resulting in little room for future milking. In other words, the “E” in P/E is distorted.

Using our RevenueShares Mid Cap Index as an example, look at how this index could be used as either a complement to your portfolio strategy or a core holding in an effort to protect against valuation risk. First we’ll take a look some individual stocks, then we’ll look at a sector, and lastly we’ll look at it on a total index level.

5 Cheapest Stocks in the S&P 400 by Price to Sales (with corresponding P/E)¹

 

Name Ticker P/S P/E % in RevMid % in S&P 400
World Fuel Services Corp INT 0.08 17.91 3.29 0.22
Tech Data Corp TECD 0.09 11.65 2.02 0.15
Ingram Micro Inc-CL A IM 0.11 12.44 3.42 0.28
Supervalu Inc SVU 0.12 14.45 1.36 0.1
Murphy USA Inc MUSA 0.13 15.58 1.38 0.13
TOTAL:       11.47% 0.88%
           

 

5 Most Expensive Stocks in the S&P 400 by Price to Sales (with corresponding P/E)¹

Name Ticker P/S P/E % in RevMid % in S&P 400
Royal Gold Inc RGLD 22.02 88.51 0.02 0.3
Gulfport Energy Corp GPOR 15.62 23.36 0.02 0.33
Federal Realty Invs Trust FRT 12.21 57.58 0.05 0.5
National Retail Properties NNN 11.05 33.65 0.03 0.28
Extra Space Storage EXR 10.86 32.51 0.04 0.36
TOTAL:       0.16% 1.77%
           

 

The 5 most expensive stocks in the S&P 400 index make up 1.77% of a market cap weighted portfolio. If you revenue weight the same index, they only constitute 0.16% of the S&P 400. The five cheapest stocks in the S&P 400 index make up 0.88%, whereas with revenue weighting they make up 11.47%. On a stock level, the RevenueShares Index shifts your exposure out of the most expensive names and into the underpriced.

Sub Sector: Real Estate

The sub-sector that currently is the most expensive (and has the highest valuation risk) is real estate. The price to sales of that sector in the market cap weighted S&P Midcap 400 Index is 5.31. In other words, for every $1 dollar of revenue in the real estate sector you’re paying $5.31. The P/E for the sector in the market cap weighted index is 40.43 ² .

Earnings from properties are typically diluted by depreciation expenses, which cause earnings on paper to become distorted. For the real estate sector especially, it is of our opinion that revenue is a better indicator of valuation than P/E.

As of 6/30/14, the RevenueShares Mid Cap Index is weighted 2.11% in real estate , while the S&P Midcap 400 is 9.13% in real estate. That’s almost a 7% reduction in exposure. The question we ask is, would you buy a stock for your client if it was trading at a 5.31 P/S and a 40.43 P/E? Maybe, but it better have a great story!

Macro Level: Total Index Comparison

 

  Price to Sales Price to Earnings
RevenueShares Mid Cap Index 0.41 20.74
S&P MidCap 400 1.30 23.25
     

 

As valuation risk becomes more and more of a concern, using RevenueShares as a compliment to your existing strategies may assist your portfolio in lessening that risk. Through reducing your valuation risk, a low price to sales strategy may result in improved investing performance.

²The P/S for the real estate sector in the RevenueShares Mid Cap Index is 3.13, and the P/E is 31.38. It’s different/lower due to our weighting methodology, which gives a higher weighting to the higher revenue stocks on a trailing 12 month basis. All data points are sourced from Bloomberg as of 6/30.

The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectus contain this and other important information about the Fund, and may be obtained by calling 888-854-8181 or visiting www.revenueshares.com. Read the prospectus and summary prospectuses carefully before investing.

An investment in the Funds is subject to investment risk, including the possible loss of principal amount invested. Fund returns may not match the return of their respective Index. The alternative weighting approach employed by the Fund (i.e., using revenues as a weighting measure), while designed to enhance potential returns, may not produce the desired results. The risks associated with each specific fund are detailed in the prospectus and could include factors such as increased volatility, small and mid cap stocks, concentration, non-diversification, financials sector risk, ADR risk, currency exchange risk, foreign market risk, growth style investing risk, portfolio turnover risk, and/ or special risks of exchange-traded funds.

Foreside Fund Services, LLC, Distributor.

An investor can not invest directly in the index

Beta: A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

The S&P 400®. The index measures the performance of the mid capitalization sector of the U.S. equity market.

An investor cannot invest directly in an index.

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