Top 3 Sectors Where Valuations Are Most Below Market Levels
MarketBeat.com | May 06, 2025 04:07PM ET
Whether focusing on growth stocks, value stocks, or a mix, the goal is the same: find and invest in undervalued assets. This thread remains true when considering how to invest across the 11 different stock market sectors. At certain times, specific sectors can see their value relative to the overall market trade at a discount.
A way to identify this is by looking at sector-specific forward price-to-earnings (P/E) ratios. As of May 2, according to Yardeni Research, the S&P 500 Index was trading at a forward P/E of just over 20. The analysis below will look at the three sectors trading the furthest below this figure, indicating that these sectors are potentially undervalued.
1. XLU: Utilities Have Tariff Resistance and Forward P/E Is Down
The first is the S&P 500 utilities sector. The Utilities Select Sector SPDR® Fund (NYSE:XLU) Fund tracks it closely. It is trading at a forward P/E of under 18x, which is around 13% below the S&P 500. This comes even as the sector is the best performing so far in 2025, with a total return of approximately 6% as of May 2. Utilities have a key advantage in today’s economy: their concentration in the United States.
The latest FactSet Earnings Insight full report shows that S&P 500 utilities companies earn 98% of their revenues from the United States. This is the highest percentage among all sectors. This means that these companies have to worry much less about the effect of tariffs. Utilities have also impressed in Q1 earnings so far. They posted the largest difference between estimated and actual revenues at almost 4%. Additionally, XLU boasts one of the highest dividend yields among the SPDR sector funds at nearly 2.8%. This can provide a valuable source of stable returns in uncertain times.
2. XLV: Healthcare Is a Q1 Earnings Standout
Second is the S&P 500 healthcare sector, which is trading at a forward P/E of just under 17x. Technically, the financial services sector is trading at a bigger discount than healthcare, with a forward P/E of just over 16. However, context is vital. The financial services sector usually trades at a forward P/E significantly below the market. Thus, it is difficult to say that the difference today indicates a significant degree of undervaluation. Rather, it seems likely that it is simply a part of the general relationship between financials and the overall market. So, it makes more sense to point to healthcare as being potentially undervalued.
Healthcare has seen extended periods in the past where its forward P/E trades significantly above or in line with that of the overall index. So, it is notable to point out that the sector’s forward P/E ratio is trading almost 17% below that of the S&P 500. Adding to the intrigue is that 90% of healthcare companies in the S&P 500 reported Q1 earnings that were above consensus estimates. This is the highest figure of any sector in Q1. It has also seen 50% of companies issue positive guidance, and 50% issue negative guidance. This stands out positively against most sectors, which have generally seen more companies report negative guidance. The highly liquid The Health Care Select Sector SPDR® Fund (NYSE:XLV) makes investing in this sector easy.
3. XLE: Low Forward P/E and Increasing Demand Could Be a Recipe for Success
Last up is the S&P 500 energy sector, which is trading at a forward P/E of 14. This is a substantial discount to the overall market at around 31%. Warren Buffett and his future successor, Greg Abel, discussed the energy and utilities sectors at the Berkshire Hathaway (NYSE:BRKa) shareholders' meeting. Abel noted that the capital required to meet the long-term projection of energy demand is "enormous." This is particularly true when thinking about data centers. The International Energy Agency (IEA) says that over the next five years, energy demand from data centers will double.
Analysts expect emerging market economies to drive rising energy demand for decades. S&P 500 energy companies can benefit from this, as over a third of their revenues come from outside the United States. According to FactSet, in line with the sector’s low forward P/E ratio, Wall Street price targets indicate a significant upside of 24% in the energy sector. This is the highest percentage of any sector. The Energy Select Sector SPDR® Fund (NYSE:XLE) is one of the most-used ETFs for tracking the sector's performance.
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