All professional investors have their preferred methods for assessing the valuations of potential investments and regular visitors to The Value Perspective will know one such favourite metric of ours is the cyclically adjusted price/earnings ratio. Known for short as the ‘CAPE’, this encapsulates the average earnings generated by a business or market over the last 10 years, adjusted for inflation.
Using it to weigh up the investment prospects for entire geographic markets – as we are about to do – is admittedly rather crude but the CAPE has been shown to be a reasonable indicator of future returns and so would seem an acceptable starting point for a discussion of where value may or may not currently exist around the globe.
As you can see from the table below, the markets that currently stand out in terms of their attractive valuations are the peripheral economies of the eurozone – the likes of Portugal, Ireland, Italy, Greece and Spain which, over the years of the euro crisis, have had to learn to live with the unflattering acronym of ‘Piigs’.
Source: Minack Advisors, December 2014
There are of course some very good reasons why they are so valued and, in articles such as Piigs might fly, we have discussed in some detail the way that smaller stock markets such as these can be dominated by just a few large businesses with the high levels of company debt and so forth that can make these top-down index numbers very misleading. So whilst there are certainly value opportunities to be found in these countries, investors should form their views of potential investments on a company-specific basis rather than blindly buying into these markets wholesale.
Remove the peripheral economies of Europe, however, and the markets currently on attractive valuations are relatively few and far between. To focus on the UK, for example, a CAPE of 15x is not expensive by historic standards but neither does it suggest that returns from this point forward are likely to be anything to shout about.
As for the US, which has topped the CAPE valuation charts for some time now … well, let’s just say that, on the basis of this crude top-down view, history suggests it will be difficult to find lots of interesting ideas there. However the US is such a deep market in terms of the number of listed companies that it can never be completely ignored by value investors as there will inevitably be a few cheap gems hidden amongst everything else.
As regular readers will know, here on The Value Perspective we are bottom-up stock-picking investors and when we scour the world’s markets for value we are still able to find interesting ideas – albeit they are somewhat thinner on the ground today than they have been in recent years.