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19/11/2024
Valuation under Trump: Optimism, scenarios, segmentation, flexible forecasts
David Bianco
Chief Investment Officer, Americas
Upon Trump’s win and the Republican sweep, we raised our S&P Earnings per share (EPS) estimates for 2025 to $275 from $270 on deregulation and expect 2026 S&P EPS to slightly exceed $300. This note provides our updated S&P EPS models that detail our earnings estimates by sectors and industries. We expect a little over 20% y/y EPS growth in 2025 from the Great Eight digital companies (AAPL, AMZN, GOOG/GOOGL, META, MSFT, NFLX, NVDA, TSLA) of the S&P 500 and near 10% from the rest in 2025; assuming the hits and risks from tariffs are offset by the benefits and confidence of lower corporate taxes. While 2024 isn’t complete, earnings results year-to-date (YTD) vs. our estimates suggest an acceleration in S&P EPS growth from about 10% this year to 10-15% next year with growth decelerating from over 30% at the Great Eight, but accelerating at the rest from about 4% this year.
Consistent with DWS macro forecasts, our 2025 S&P EPS estimates incorporate 2.0% US Gross domestic product (GDP) growth and 2.4% Inflation, which will assist earnings growth, but also West Texas Intermediate (WTI) oil falling to $65/bbl and the euro falling to $1.02 at 2025 end, which will weigh on S&P EPS growth. Global GDP is expected to be decent, with some acceleration in Europe to 1%, 1.2% in Japan, but China decelerates to 4.2% given likelihood of tariffs and its internal challenges.
Our intrinsic valuation framework rests on three inputs, which we think valid for any equity.
1) We estimate normalized earnings by sector, considering the macroeconomic and sector specific business cycle and we also consider the accounting quality of the non-GAAP (Generally accepted accounting principles) EPS.
2) We estimate the Cost of equity (CoE) by sector, we observe and forecast 10-year Treasury yields and particularly 10-year Treasury Inflation-Protected Securities (TIPS) yields to estimate the long-term real risk-free interest rate and then we add an equity risk premium to account for the uncertainty of equity returns.
3) We determine whether the anchor or steady-state valuation – determined by normalized EPS capitalized at the real cost of equity – warrants a premium (or discount) for long-term economic profit growth (or fading). If a sector can generate long-term EPS growth over its nominal cost of capital less its Dividend yield, it typically suggests rising economic profits.
The ongoing shifting sector composition of the S&P 500 from value to growth sectors, requires considering a significant growth premium for the S&P 500 in aggregate today. In the past, it was unusual for the S&P 500 in aggregate to sustain a significant premium price-to-earnings (PE) vs. its steady-state PE applied to non-GAAP EPS. It’s because of issues such as this, that we have found it very helpful to model the earnings and the valuation of the S&P 500 using a middle-up approach or sector-by-sector approach and not just top-down. Our valuation framework has its top-down model integrated with our sector/industry valuation models.
As said, we expect a bit over 20% EPS growth in aggregate from the Great Eight in 2025 and probably 15% in 2026 and perhaps 10-15% for the rest of the decade for most. These companies have strong balance sheets and Free Cash Flow (FCF) and most have $1Trillion+ market caps. Our S&P 500 targets and supporting Intrinsic value estimates assume a 5.25% real cost of equity. Thus, most of the Great Eight should be near 5.0% real CoE or 7.5% nominal, in our view. This real CoE and long-term EPS growth outlook for the Great Eight, generally supports 25-30 PEs on 2025 EPS today or 25-50% growth premiums. Our models assign growth premiums by industry, mindful of certain companies dominating. While differing across industries, we think our growth premium estimates are generous for all, but some still trade at higher valuations and some less. Thus, opportunities for selection exist even within this this advantaged group of stocks that have been winning and winning for so long.
After likely near 10% EPS growth in 2025, we think S&P 492 EPS growth slows to 5% to 8% for the rest of the decade or until next recession. This plus dividend yields of near 1.5%, should deliver upon an 8% nominal or 5.5% real CoE with an unchanged PE. The unchanged or fair sustainable PE should be about 18 or 1/5.5%. Thus, unless one sees EPS growth differently, we think both the Great Eight and S&P 492 are fairly valued relative to each other and both are at full fair values inclusive of optimistic outlooks.
Our sector strategy is overweight Health Care, Financials, Capital Goods and Utilities. Underweight conventional Retailers, Auto, Semiconductors, Materials, and Real Estate Investment Trusts (REITs). We added selectively to Capital Goods and parts of Energy that are combustion plays (fossil fuel users) and some Transports, moving from Airlines to Airfreight & Logistics upon expected inventory building before tariffs.
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