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Implications Of An Overvalued Market On Corporate Merger And Acquisition Activity

Over the past few months, the mergers and acquisition market has experienced a wave of large “mega” deals.  These deals include Bayer’s $65 billion acquisition of Monsanto and SoftBank’s $31.5 billion acquisition of ARM Holdings.  While on the surface these transactions may suggest that now is the time to execute inorganic growth strategies, a deeper look at the market and the fundamentals driving company growth paint a very different picture across most of the 11 GICS industries.  Key takeaways from our analysis include: 

  1. While the S&P 500 is close to all-time highs, the reported earnings per share of S&P 500 companies have been falling since 2014.
  2. Across the eleven GICS industries, only four industries (consumer discretionary, consumer staples, healthcare and industrials) have positive average compounded annual growth rates from 2013 to 2016.
  3. Corporate development officers considering investments in the other seven GICS industries with negative average compounded annual growth rates should exercise caution as their targets could be overvalued and expensive.


S&P 500 Index By Year

The first part of our analysis concentrated on the S&P 500.  Using the S&P Capital IQ platform, we built a stock price chart of the index over the last ten years as displayed above.  The two important takeaways are: 1) the S&P 500 is trading close to an all-time high and 2) the S&P 500 is significantly above pre-recession levels in 2007.  On the surface, there is no reason to assume that the current trend of increasing market values for S&P 500 companies will change.

EPS of S&P 500 Companies by Year

However, in the above chart, we see that the earnings per share of S&P 500 companies have clearly been declining since 2014.  This would then suggest that the market is overvalued since the market values of S&P 500 companies are trading at or close to all-time highs while their earnings per share have been declining.  This is a difficult prospect to digest so we decided to dig a little deeper and understand which industries in the S&P 500 have been experiencing earnings growth over the last three years and those that have been experiencing earnings decline.

Average Compounded Annual Growth Rate of S&P 500 Companies by Industry 2013-2016

As the above chart demonstrates, only four of the GICS industries have positive growth rates over the past three years while seven of the GICS industries have negative growth rates.  This analysis would suggest that investments and/or corporate assets to be considered for inorganic growth opportunities in the energy, financials, information technology, materials, real estate, telecommunication services and utilities could be expensive and overvalued. 

The main reason for this conclusion is that it seems like market momentum or the trend of increasing market prices is driving valuations rather than fundamentals in the seven industries with negative compounded annual growth rates.  While every situation is different and should be considered fully, we would caution investment and corporate managers to keep this analysis in mind when considering their next investment. 

Learn more about the tools and products used for this analysis, and read additional blogs on market trends and industry commentary.

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Sep 29, 2016