Valuations Can Help in Evaluating Sectors

Along with other factors, comparing current sector valuations to longer-term averages has helped investors as they make decisions about whether to rotate in or out of specific sectors.

For example, the first thing to notice on both the price-to-earnings (P/E) and price-to-book (P/B) charts below is how, for many sectors within the MSCI World Index, the most current measurement is above the top quartile of the distribution. In other words, during this period, more than 75% of the measurements would have been lower than the current level.

Digging into the numbers a bit more, we see that, perhaps unsurprisingly, information technology (IT) looks expensive relative to its history. What is more surprising is the magnitude of the gap between current and historical averages, for both P/B and P/E. Over the last few years, IT companies have delivered impressive financial results on the back of increased demand, meaning investors are willing to pay a premium in the expectation that future business growth will follow the same trend.

We saw a similar picture for most sectors, with current P/B and P/E measurements above the median or above the top quartile. The only exceptions were financials, health care and materials, when examined from a P/E perspective.

Regardless of how different investors may interpret these findings, they may be useful to differentiate across sectors.