One result of a slew of downward earnings revisions — the scenario with which investors are contending today — is that equity valuations are retreating. Persistently high inflation is having a similar impact. Combine those factors and a case can be made that valuation alone isn’t a reason to buy or sell a stock. Particularly when acknowledging some of the flaws in basic valuation metrics, such as price-to-book and price-to-earnings ratios. Those flaws also underscore the benefits of focusing on purity when accessing value stocks — an objective accomplished by the Invesco S&P 500 Pure Value ETF (RPV). The exchange traded fund follows the S&P 500® Pure Value Index, which is a departure from basic value benchmarks, and whose differences are magnified in the current environment.
“Valuation analysis is somewhat crude, subject to interpretation, influenced by inflation (among other things), and often impacted by investor sentiment conditions. In terms of the latter, it’s why we often remark that valuation is as much a sentiment indicator—or better put, an indicator of sentiment—as it is a ‘fundamental’ indicator of the market’s inherent attractiveness,” according to Charles Schwab research.
Using a combination of growth and value factors, S&P generates a ratio between the growth score and the value score, resulting in S&P 500 member firms being classified as deep value, deep growth or blend names. Obviously, those with the deep value designation are eligible for inclusion in RPV’s underlying index.
That’s one sign of the ETF’s value purity, and a relevant one at a time when macroeconomic factors, such as inflation and rising interest rates, are having a clear effect on equity valuations.
“Unsurprisingly, several valuation measures with a profit or economic metric in the denominator have declined sharply. Conversely, yield-based metrics (such as the Fed model and equity risk premium) have gotten relatively more expensive courtesy of the rise in interest rates,” added Schwab.
RPV offers some positive correlation to rising rates by way of a 22.41% weight to financial services stocks. The ETF’s vulnerability to that scenario is lower than that of traditional value funds by way of a mere 2.28% combined weight to the rate-sensitive utilities and real estate sectors.
Other sector benefits offered by RPV include the ETF’s 8.67% tech weight. Not only is that significantly below what’s found in broader market benchmarks, it also serves the aim of reducing the fund’s exposure to rising rates because Fed tightening makes the future cash flows of growth companies less appealing.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
