As valuations have ticked up across the stock market as a whole, some names in particular have gotten way more expensive. And interestingly, they're nearly all energy stocks.
A comparison of current forward price-to-earnings ratios to their price-to-earnings ratios one year prior finds that seven S&P 500 stocks are currently trading at forward valuations more than three times higher than their valuations one year ago.
The forward price-to-earnings ratio is a quick and popular way for investors to determine just how expensive a given stock is.
The calculation is simple: The current price of a stock is divided by analysts' average expectation of how much money a company will earn, per share, over the next year.
The assumption here is that investors buy a given stock in anticipation of the money that the company is about to earn. And to make it a fair comparison, the year-ago forward P/E is here computed by using the earnings analysts expected at the time, rather than the actual results.
What's striking is just how many energy stocks are included among the biggest P/E gainers. Out of the top seven valuation risers, only one is a non-energy name: red-hot Netflix.
Out of the the top 14, all but three are energy stocks (the two other exceptions being Amazon and Yahoo). And on top of that, there are seven stocks that are not included in this analysis because their earnings expectations have gone from positive to negative, making the P/E metric meaningless. These stocks have arguably seen their valuations rise even more than those still expected to turn a profit.
Unsurprisingly, the jump in energy valuations doesn't come from increased optimism about the what the future will bring. The energy stocks with the biggest valuation rises have all seen their prices fall over the past year, in some cases quite dramatically. But prices simple haven't fallen as quickly as future earnings estimates have.
Why's that? Well for starters, there is clearly a market expectation is that energy prices will bounce higher in the longer run. But in addition, most energy stocks have managed to maintain their dividends, making many of these stocks quite attractive as yield plays even at current levels.
Still, some investors see the broad rise in energy valuations as a clear red flag.
"We would still like to be careful in this area," said Curtis Holden, senior investment officer at Houston-based Tanglewood Wealth Management. A broad slowdown in emerging markets will "probably keep energy prices somewhat depressed for a while…. We're not certain that we've seen the bottom in prices for these stocks yet."
Taking a technical perspective, Ari Wald of Oppenheimer sees reason to be wary of the above energy stocks as well.
"When selling based on a screen of stocks that have risen the most in terms of valuation on their P/E, it is generally better to sell those that have a falling 'E,' rather than those that have a very strong, rising 'P,' " Wald said in a Friday "Trading Nation" interview, referring to expected earnings and share price, respectively.
For a stock like Netflix, he points out, valuations are rising due to a strong stock rally with a great deal of momentum behind it, and in such cases, "valuation tends to be a very poor timing indicator."
But when it comes to energy stocks which have become "very expensive due to a falling 'E,' those are your sell ideas, especially because there's a very poor technical trend behind it as well," said Wald.
Specifically, the technician says that the weakest-looking stock in the bunch is Range Resources.
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