by Tajinder Dhillon.
Effective Monday March 20th, 2023, 14 constituents in the S&P 500 have been impacted by a GICS Classification change which was originally announced in December 2022.
As shown in Exhibit 1, 14 constituents across two sectors will move into three new sectors (level 1). The largest change will be within Information Technology, where eight constituents will move to the Financials sector, followed by three constituents moving into the Industrials sector. From a market cap perspective, Visa and Mastercard will be the largest change who now rank as the 3rd and 4th largest constituent in the Financials sector and move into a newly created sub-industry (level 4) titled ‘Transaction & Payment Processing Services’.
The other sector impacted is Consumer Discretionary, which will see Target Corp, Dollar General Corp, and Dollar Tree Inc all move into the Consumer Staples sector and ‘Consumer Staples Merchandise Retail’ sub-industry. Target Corp now ranks as the 9th largest constituent in the Consumer Staples sector.
Exhibit 1: GICS Classification Impact on S&P 500 (click image to view full screen)
As we enter 2023 Q1 earnings season in April, we look at the impact on both y/y earnings growth and earnings weight by sector using data from March 17th (old classification) and March 24th (new classification). Y/Y growth rates saw a minimal impact for both 2023 Q1 and full-year 2023, and instead, we see a more notable change in the earnings weight at a sector level.
As shown in Exhibit 2, Financials will see the largest increase in earnings weight next quarter, rising from 17.6% to 19.7% (+2.1 ppt) due to Visa Inc and Mastercard Inc, followed by Industrials (+0.3 ppt), which will be offset by the decline in Information Technology (-2.6 ppt).
Consumer Staples will see its earnings weight rise moderately (+0.4 ppt) which will be offset by Consumer Discretionary (-0.3 ppt).
We also include an additional graph showing the same data but for full-year 2023 estimates. We note Financials has an earnings weight of 19.7% post-classification, far greater than its current market-cap weight of 12.9%, which indicates some form of value being offered. Conversely, Information Technology has its earnings weight reduced to 18.9%, far less than its market-cap weight of 26.1%, which partially contributes to the premium paid for companies in this sector.
Exhibit 2: 2023 Q1 and 2023 Earnings Weight Impact
Financials was most impacted by the classification change, and we dive further into this sector by looking at the newly created sub-industry in more detail.
The Transaction & Payment Processing Services (TPPS) sub-industry will consist of eight constituents (mostly coming from the legacy Data Processing & Outsourced Services sub-industry) including Fidelity National Information Services Inc, Fiserv Inc, Global Payments Inc, Mastercard Inc, PayPal Holdings Inc, Visa Inc, Fleetcor Technologies Inc, and Jack Henry & Associates Inc. The remaining constituents in this legacy sub-industry now move to Industrials which includes Automatic Data Processing Inc, Paychex Inc, and Broadridge Financial Solutions Inc.
As a group, TPPS widely outperformed its benchmark sector (Financials) and the broader index in 2022 Q4, with an earnings growth rate of 12.7% compared to a growth rate of -8.9% for Financials and -3.2% for the S&P 500. We note a similar observation when looking at full-year 2022, with TPPS delivering a 15.3% earnings growth rate in comparison to -13.2% for Financials and 4.8% for the broader index.
Based on analyst expectations, TPPS is expected to marginally outperform the broader sector and strongly outperform the broader index in 2023 Q1.
TPPS is also expected to significantly outperform the S&P 500 on a full-year 2023 basis due to strong expected y/y growth rates from Visa Inc, Mastercard Inc, and PayPal Holdings.
Exhibit 3: Earnings Growth Rate for Transaction & Payment Processing Services Sub-Industry
From a valuation perspective, many companies in TPPS trade at a substantial premium to its parent sector. TPPS as a group trade at a forward P/E of 21.1x in comparison to 12.6x for Financials and 17.9x for the S&P 500. This results in the Financial sector seeing its forward P/E rise from 11.7x to 12.6x which becomes more ‘growthy’.
Exhibit 4: Forward P/E for S&P 500 Sectors
We conclude by looking at the forward net profit margin for each sector, which sees Financials being the largest beneficiary of the classification change with a +1.1 ppt improvement (18.9% today vs. 17.8% prior), which is offset by a -0.7 ppt decline in Information Technology.
The improvement in net profit margins can be explained by Visa Inc and Mastercard Inc which has a current forward 12-month net profit margin estimate of 54.6% and 46.6% respectively, far greater than the traditional banks of JPMorgan Chase (27.1%), Bank of America (27.2%), Citigroup Inc (14.9%) and Wells Fargo Inc (23.0%).
Exhibit 5: Forward Net Profit Margin for S&P 500 Sectors
The GICS classification change resulted in 14 constituents moving into new sectors. Financials saw the largest change, with 8 of these constituents move from Information Technology into Financials.
Financials also saw a newly created sub-industry which comprises of payment processors including Visa Inc and Mastercard Inc. Financials will have a marginal increase in its earnings weight, forward P/E ratio, and forward net profit margin based on current analyst estimates.
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