In the previous blog post we used the Finbox API service to calculate the implied equity risk premium of the S&P 500. Using the Finbox API service we can also do an intrinsic valuation of the S&P 500.
Background
We live in extraordinary and challenging times. The novel Coronavirus (SARS-CoV-2) and related disease (COVID-19) has been spreading around the world for almost three months now. People around the world are urged or forced to stay at home to help governments and communities get the virus under control. The coronavirus will undoubtedly have a lasting impact on our lives.
The virus has already made severe impact on businesses around the world. First, when the Hubei province in China shut down, many global supply chains were also shut down. Now, as more people around the world are no longer able to go to work, many businesses are suffering from a steep decline in demand. For example, the tourism and airline industries have come to a complete halt as people stay at home. A lot of businesses may go under and a lot of people may lose their jobs. And without people earning money to spend, businesses will see a further decline in sales.
Stock markets around the world have also dropped significantly. The Dow Jones dropped more than 35% from 29,551 points on February 12, 2020, to 19,174 points on March 20, 2020. Similarly the S&P 500 Index fell almost 32% from 3386 points on February 19, 2020, to 2305 points on March 20, 2020. The German DAX Index fell over 38% from 13,789 points on February 19, 2020, to 8,442 on March 18, 2020. Fueled by an oil price war, we’re looking at the “fastest bear market” ever.
From February 26, 2020, NYU Stern professor Mr. Aswath Damodaran began covering the impact of the virus on the markets on his blog and YouTube channel:
- 26/02: A Viral Market Meltdown: Fear or Fundamentals? (blog, youtube)
- 09/03: A Viral Market Meltdown Part II: Clues in the Debris! (blog, youtube)
- 16/03: A Viral Market Meltdown III: Pricing or Value? Trading or Investing? (blog, youtube)
- 23/03: A Viral Market Meltdown IV: Investing for a post-virus Economy (blog, youtube)
- 31/03: A Viral Market Meltdown V: Back to Basics! (blog, youtube)
- 08/04: A Viral Market Meltdown VI: The Price of Risk (blog, youtube)
- 24/04: A Viral Market Update VII: Mayhem with Multiples (blog, youtube)
- 13/05: A Viral Market Update VIII: A Crisis Test – Value vs Growth, Active vs Passive, Small Cap vs Large! (blog, youtube)
- 04/06: A Viral Market Update IX: A Do-it-Yourself S&P 500 Valuation (blog, youtube)
- 19/06: A Viral Market Update X: A Corporate Life Cycle Perspective (blog, youtube)
- 02/07: A Viral Market Update XI: The Flexibility Premium (blog, youtube)
- 23/07: A Viral Market Update XII: The Resilience of Private Risk Capital (blog, youtube)
- 20/08: A Viral Market Update XIII: The Strong (FANGAM) get Stronger! (blog, youtube)
- 05/11: A Viral Market Update XIV: A Wrap on the COVID market, premature or not! (blog, youtube)
In the third blog post, Damodaran provided an updated intrinsic valuation of the S&P 500 index ranging between $2,547.91 (20%) to $2,986.04 (80%).
Using the same Finbox tools we used in our previous blog post, we can also do an intrinsic valuation of the S&P 500.
Data Gathering
To value the S&P 500 index we need the following data inputs:
- Long-term risk-free rate: 10Y US bond yield (Wikipedia)
- Company information (Finbox API)
- Current market capitalization (marketcap)
- Dividends paid LTM (total_div_paid_cf)
- Stock buybacks LTM (common_rep)
- Stock issues LTM (common_issues)
- Net income LTM (ni)
- Book value of equity FY (total_equity)
To estimate the current value of the S&P 500, we want to use the most up to date information available. That’s why for most metrics we use the last twelve months data points.
Dividend and Buyback Computation
After gathering the raw data, we normalize by weighing the current S&P 500 index against the S&P 500 total market capitalization.
At the moment of writing, March 23, 2020, the index units adjusted data points are:
- Earnings: $142.92
- Dividends: $57.44
- Buybacks: $81.50
- Issuances: $138.94
- Cash to Equity: $138.95 (dividends + buybacks)
- Net Cash to Equity: $129.52 (dividends + buybacks – issuances)
S&P 500 Valuation Inputs
- Base Earnings: $142.52
- Base Net Cash Yield: $129.52
- Expected Y1 earnings growth: PERT distribution (min -25%, mode -5%, max 5%)
- Expected Y2 to Y5 earnings growth: triangle distribution (min 4%, 7%, 10%)
- Expected long term riskfree rate: triangle distribution (min -0.51%, mode 0.89%, max 1.5%)
- Sustainable payout ratio in Y5: 1-g/ROE
- Equity risk premium: triangle distribution (min 5%, mode 7.18%, max 9%)
S&P 500 Intrinsic Valuation
In the chart below you can find a histogram plot of the S&P 500 intrinsic value. It ranges from $2,001.58 (25%) to $2,425.66 (75%) with a mean of $2,211.15.
