LM Market Insight: U.S. EQUITIES: VALUATION & FUNDAMENTALS DEC 2015 THIS MATERIAL IS ONLY FOR DISTRIBUTION IN THOSE COUNTRIES AND TO THOSE RECIPIENTS LISTED. PLEASE REFER TO THE DISCLOSURE INFORMATION ON THE FINAL PAGE. IN THE UNITED STATES -
Are current equity valuations stretched? S&P 500 valuation measures Sources: Bloomberg, S&P Dow Jones Indices and S&P Shiller Market Data, as of 11/30/15. Nov 2015 P/E is based on 4Q15 earning estimates and index price as of 11/30/15. The forward P/E is based on quarterly S&P earnings estimates through December 2016. This information cannot be guaranteed and all liability is disclaimed on S&P s own behalf and on behalf of its information providers for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. * The Price/Earnings average is based on the quarterly operating P/E since December 1988; all others are 20-year averages. Please see pages 10-12 for important disclosures and definitions of terms Page 2
S&P 500 is no longer cheap on a P/E basis S&P 500 P/E ratio: trailing 12 months and forward basis Price to Earnings Ratio 35 30 25 20 15 10 5 S&P 500 Cyclically-Adjusted Price Earnings (CAPE) Ratio 50 45 40 35 30 25 20 15 10 5 0 Dec 88 Dec 92 Dec 96 Dec 00 Dec 04 Dec 08 Dec 12 Dec 16 0 Dec-56 Mar-62 Jun-67 Sep-72 Dec-77 Mar-83 Jun-88 Sep-93 Dec-98 Mar-04 Jun-09 Sep-14 Recession P/E Forward P/E Avg since 12/88 Recession CAPE AVG The S&P 500 P/E ended November 2015 at 20x above its average of 18.7x since December 1988. 2016 forward P/E was16.5x as of 11/30/15, based on estimated earnings for calendar year 2016. The CAPE ratio ended August 2015 at 26.3x vs. a long-term average of 19.6x. 1 Note: some argue this measure now overstates valuation because of accounting changes that may have introduced significant distortions into the calculation. Sources: S&P Dow Jones Indices and S&P Shiller Market Data, as of 11/30/15. Aug 2015 P/E is based on 4Q15 earning estimates and index price as of 11/30/15. The forward P/E is based on quarterly S&P earnings estimates through December 2016. This information cannot be guaranteed and all liability is disclaimed on S&P s own behalf and on behalf of its information providers for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Please see pages 10-12 for important disclosures and definitions of terms Page 3
Other popular valuation measures tell a similar story S&P 500: Price-to-Book & Price-to-Sales 6 5 4 3 2 1 S&P 500: Price-to-Cash Flow & EV-to-EBITDA 20 18 16 14 12 10 8 6 4 2 0 0 Dec 95 Dec 97 Dec 99 Dec 01 Dec 03 Dec 05 Dec 07 Dec 09 Dec 11 Dec 13 Dec 95 Dec 97 Dec 99 Dec 01 Dec 03 Dec 05 Dec 07 Dec 09 Dec 11 Dec 13 P/B Ratio P/S Ratio Avg P/B Avg P/S P/CF Ratio EV/EBITDA Avg P/CF Avg EV/EBITDA At the end of Nov 2015: Price-to-book was 2.8x, below its 20-year average of 3.0x. Price-to-sales was1.8x, above its 20-year average of 1.5x. Price-to-cash flow was 10.9x, below its 20-year average of 11.6x. At the end of November 2015 Based on Enterprise Value - to - EBITDA, the S&P 500 traded at 12.7x, above its 20-year average of 11.0x. Source: Bloomberg, as of 11/30/15. See page 9 for index definition. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Please see pages 10 12 for important disclosures and definitions of terms Page 4
From an income standpoint, stocks compare favorably with Treasuries S&P 500 dividend per share and payout ratio $45 80% S&P 500 earnings and dividend yield; 10yr UST yield 10% $40 $35 70% 60% 8% Dividend per share $30 $25 $20 $15 50% 40% 30% Dividend payout ratio Yield (%) 6% 4% $10 20% 2% $5 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 10% 0% 0% Dec-95 Dec-99 Dec-03 Dec-07 Dec-11 S&P 500 Dividends (left axis) S&P 500 Dividend Payout Ratio (right axis) Recession S&P 500 Earnings Yield 10yr UST Yield S&P 500 Dividend Yield Dividends have experienced solid growth. Record high dividend per share, but at 40% the payout ratio is below its historical average of 48% since 1950 Record corporate cash suggests potential for continued dividend growth Stock yields compare favorably to UST yields As of November 30: S&P 500 earnings yield = 5.4% S&P 500 dividend yield = 2.1% 10yr UST yield = 2.21% Sources: S&P Dow Jones Indices, S&P Shiller Market Data and Bloomberg. Dividend per share data, S&P 500 earnings yield data, S&P 500 dividend yield data and 10-year UST yield data as of 11/30/15. Dividend payout ratio as of 9/30/15. This information cannot be guaranteed and all liability is disclaimed on S&P s own behalf and on behalf of its information providers for any damages or losses arising from any use of this information. See page 9 for index definition. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Please see pages 10 12 for important disclosures and definitions of terms Page 5
Fundamentals could provide support for prices S&P 500 Operating Earnings, actual and estimated $140 S&P 500 profit margin 12 Earnings $120 $100 $80 $60 $40 $20 10 8 6 4 2 0 Dec 88 Dec 92 Dec 96 Dec 00 Dec 04 Dec 08 Dec 12 Dec 16 Sep 95 Sep 97 Sep 99 Sep 01 Sep 03 Sep 05 Sep 07 Sep 09 Trailing 12 month profit margin Sep 11 Sep 13 Sep 15 Recession S&P Annual Earnings Estimated Recession Profit Margin Average After a record recovery from the last recession, earnings growth has stalled; rebound seen in 2016 As of 11/30/2015, S&P 500 earnings growth for the 12-months ended 12/31/15 is estimated to be down -5.6% from a year earlier compared with a gain of 5.3% in December 2014. As of 11/30/2015, S&P 500 earnings are expected to grow 18.6% to $126.5 at the end of 2016. S&P 500 profit margin is down from recent peak, but still high Profit margin was 8.3% as of 11/30/15, down from a high of 9.6% in September 2014. Sources: S&P Dow Jones Indices and Bloomberg, as of 11/30/15. This information cannot be guaranteed and all liability is disclaimed on S&P s own behalf and on behalf of its information providers for any damages or losses arising from any use of this information. See page 9 for index definition. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Please see pages 10-12 for important disclosures and definitions of terms Page 6
Sales growth has been slow, but debt is down and free cash flow is up since the financial crisis S&P 500: revenue per basic share $1,400 S&P 500: total debt and free cash flow $1,400 $140 $1,200 $1,000 $800 $600 $400 $200 Total debt, billions $1,200 $1,000 $800 $600 $400 $200 $120 $100 $80 $60 $40 $20 Free cash flow per share Dec 95 Dec 99 Dec 03 Dec 07 Dec 11 Recession Revenue per share Linear (Revenue per share) Sep-95 Sep-99 Sep-03 Sep-07 Sep-11 Sep-15 Recession Total Debt Free Cash Flow Per Share Sales were slower to rebound than corporate profits and earnings. following the recession and have recently stalled Sales growth could accelerate if the recovery broadens, particularly given pockets of pent-up demand. Total debt remains well below pre-recession levels Free cash flow is well above pre-recession levels Source: Bloomberg, as of 11/30/15. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Please see pages 10 12 for important disclosures and definitions of terms Page 7
Economy-wide, after-tax corporate profits and corporate cash are near record high levels US After-tax corporate profits $2,000 US corporate cash $2,500 $1,600 $2,000 Billions $1,200 $800 Billions $1,500 $1,000 $400 $500 Sep-95 Sep-99 Sep-03 Sep-07 Sep-11 Sep-15 Sep-95 Sep-99 Sep-03 Sep-07 Sep-11 Sep-15. Source: Bloomberg, as of 9/30/15. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Corporate profits are represented by domestic non-farm non-financial corporate business liquid assets. Please see pages 10 12 for important disclosures and definitions of terms Page 8
Fundamentals matter more as valuations rise Investors appear cautious about higher valuations Outflows from long-term domestic equity funds may reflect elevated skepticism That s unusual for market tops, which have generally been associated with investor exuberance While a fairly valued market implies fewer outright bargains, it does not mean there are no attractive opportunities in today s market That underscores the potential value of active stock pickers who focus on the fundamental strengths and weaknesses that differentiate individual firms Domestic equity funds: 12 month cumulative net new cash flow Billions $50 $50 $100 $150 $200 Nov 08 Nov 09 Nov 10 Nov 11 Nov 12 Nov 13 Nov 14 Nov 15 Source: Investment Company Institute, as of 12/16/15. Nov 2015 flows are estimated as of week ended 12/9/15. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Please see pages 10 12 for important disclosures and definitions of terms Page 9
Investment risks: The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. Common stocks generally provide an opportunity for more capital appreciation than fixed-income investments but are subject to greater market fluctuations. Investments in small-cap and mid-cap companies involve a higher degree of risk and volatility than investments in larger, more established companies. Fixed income securities are subject to interest rate and credit risk, which is a possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt. As interest rates rise, the price of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. U.S. Treasuries are direct debt obligations issued and backed by the full faith and credit of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities. Active Management does not ensure gains or protect against market declines. Yields and dividends represent past performance and there is no guarantee they will continue to be paid. Please see pages 10-12 for important disclosures and definitions of terms Page 10
Definitions of terms: The cyclically adjusted price-to-earnings ratio (CAPE) is defined as price divided by the average of ten years of earnings, adjusted for inflation. Dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its share price. The earnings yield is the earnings per share for the most recent 12-month period divided by the current market price per share. It is the inverse of the P/E ratio. EV / EBITDA equals a company's enterprise value divided by earnings before interest, tax, depreciation, and amortization. It measures the price (in the form of enterprise value) an investor pays for the benefit of the company's cash flow (in the form of EBITDA). The forward P/E ratio is a stock s (or index s) current price divided by its estimated earnings per share (or estimated index earnings), usually oneyear ahead. Free cash flow (FCF) is measure of financial performance calculated as operating cash flow minus capital expenditures. It represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. FCF is important because it allows a company to pursue opportunities that enhance shareholder value. Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time. Operating earnings is profit earned after subtracting from revenues those expenses that are directly associated with operating the business, such as cost of goods sold, administration and marketing, depreciation and other general operating costs. The price-to-book (P/B) ratio is a stock's price divided by the stock s per share book value. The price-to-cash flow (P/CF) ratio is a stock's price divided by the amount of cash generated per share by a company's operations. The price-to-earnings (P/E) ratio is a stock's price divided by its earnings per share. The price-to-sales (P/S) ratio is a stock's price divided by its sales per share. The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Please see pages 10-12 for important disclosures and definitions of terms Page 11
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