valuation

James Mackintosh

Are emerging markets a bargain or yet another proverbial falling knife?

More bargain-hunters are starting to appear. Today Barclays equity strategists Dennis Jose, Ian Scott and Joao Toniato went so far as to recommend buying Russia’s Gazprom and Sberbank (along with China Shipping Development Co) to gain EM exposure.

Could emerging markets be the most-disliked region currently? They have been punished by investors, underperforming developed market equities by nearly 35% since Nov 2010, considerably worse than what would be suggested by their earnings (Figure 2). Amongst sellside analysts, a Bloomberg poll seems to indicate that few research houses recommend an
overweight on EM equities. From our meetings as well, we find most investors have little sympathy for our recent call to overweight EM equities

A few rather nice Barclays valuation charts after the break, plus some caution.

 

James Mackintosh

Money has been piling into European shares as fears of the euro imploding recede, the economy shows signs of life and investors look for the next trade after Japan.

But the “eurozone shares are cheap” theme might have run its course. This chart shows the discount of eurozone forward price-to-earnings compared to the US, as a percentage (using MSCI indices). 

James Mackintosh

Investors have used all sorts of valuation models in the past 20 years. Which to use for Twitter, now that it is preparing to float?

Here’s another handy measure: price per worker. Twitter is more than its staff, of course. But it’s a useful sanity check on any valuation. The higher the value, the more investors have to assume there’s something really special about their assets – factories (a carmaker), intellectual property (think cure for cancer), innovative culture (Apple?), near-monopoly position (once Microsoft, now Google). 

John Authers

Cyclically-adjusted price/earnings multiples (CAPEs), as made famous by Yale’s Professor Robert Shiller, are growing inconvenient for the brokerage community.

Last week, BofA Merrill Lynch’s Savita Subramanian pointed out that of 15 popular measures of equity valuation, CAPE (which compares share prices to a 10-year moving average of real earnings) was the only one that made stocks look expensive. The list of valuations suggesting US stocks are either cheap or at fair value includes:

  • trailing p/e
  • forward consensus p/e
  • trailing normalised p/e
  • price/book
  • enterprise value/ebitda
  • forward PEG (p/e ratio divided by growth)
  • trailing PEG
  • price/operating cash flow
  • price/free cash flow
  • enterprise value/sales
  • market-based equity risk premium
  • normalised equity risk premium
  • S&P 500 in WTI oil terms
  • and S&P 500 in gold terms

CAPE is thus beginning to stick out like a sore thumb. As it has been showing that stocks are expensive throughout most of the current rally, there is now a widening attempt to discredit or ignore it. Merrill’s own complaint is typical:

The Shiller P/E, which is based on inflation-adjusted earnings over the past 10 years, currently suggests that stocks are overvalued. However, this metric
assumes that the normalized (cyclically-adjusted) EPS for the S&P 500 is today less than $70—well below even our recessionary scenario for EPS. The
methodology assumes that the last 10 years is a representative sample, but the most recent profits recession was the worst we have seen and was exacerbated by a high leverage ratio which has since been dramatically reduced. Assuming that this scenario is going to repeat itself is, we think, overly pessimistic

But is it? Earnings volatility has certainly been extreme over the last decade, and arguably unprecedented. But if anything that suggests that the measure – which grew famous from efforts to predict the bursting of the dotcom bubble in 2000 and to show that the 2003-07 bull market was a “fools rally” – is more, not less, useful. That is the contention of Prof Shiller himself, and it is a reasonable one. More on this, with charts, and some comments from Prof Shiller, after the break. 

James Mackintosh

Even after the extraordinary summer rally in European equities, strategists continue to punt European shares as cheap, and so worth buying. Unfortunately, it’s more complicated than that.

The sell-side analysts pushing the idea are too numerous to list, but one of the better argued cases is that presented by the cyclically-adjusted price-earnings ratio (CAPE), which averages profits over 10 years in an attempt to eliminate the effects of the economic cycle.

Paul Jackson at Societe Generale has some nice charts showing Europe looks cheap, and demonstrating the use of one derivative of CAPE, the cyclically-adjusted dividend yield.

CAPE vs its average