Valuations of markets

In the June newsletter, I shared that some sentiment readings, which are proven contradictory indicators, suggested that markets were oversold and that a rally was highly likely. Share prices have recovered since.

However, over the years, I have learnt that prices are driven by sentiment and news events over the short term, but that valuations are the determinant of prices over the long term. The key takeaway is that speculators should watch news events and updates while investors should be more focused on valuations of companies and the merits of an investment.

There are various criteria available to investors – e.g. price to book value ratios, cash flow conversions and free cash flow, return on shareholders’ equity, projected profit growth, etc. However, price-earnings ratios (P/Es) are a very meaningful basic indicator of valuations.

Looking at the US S&P 500 Index, the forward P/E is 17.7 times compared to the 17 times average P/E over the previous decade. However, the so-called MegaCap-8 (shares) have a significant impact on the current valuation of the S&P 500, being a group of companies representing 24% of the S&P 500’s market value. The Megacap-8 comprise Alphabet, Amazon, Apple, Meta, Microsoft, Netflix, NVIDIA and Tesla.

As the chart below shows, this group of shares is expensive and will remain expensive – especially compared to, for example, the US S&P 400 and 600 Indices, which represent medium and small enterprises. These indices currently trade at forward P/Es of 13 times, a cheap valuation on all counts. So, I believe aggressive investors may well wager a few bucks on these indices, hoping for a recovery in prices on the indices.    

Turning to the other side of the Atlantic and specifically looking at Germany, the largest economy on the European continent, we see that the MSCI Germany Index is currently trading at the same forward P/E as in March 2020, at the onset of Covid-19 lockdowns. Since 1995, valuations have only been cheaper on three occasions: in 2008, 2011 and 2012. So, based on valuation, the German market is cheap despite the dark energy clouds affecting the short-term picture whilst Germany is highly dependent on Russian energy sources.

Looking ahead, there is still uncertainty for investors – as there has always been in the past and will be in the future.

If investors wait until the point and place of no uncertainty is reached, then share and asset prices will probably have increased by 20%!

Equity markets are reasonably and fairly priced, thus creating opportunities for long-term investors.

This article contains general information only. It does not constitute financial, tax, legal or investment advice and the companies in the PSG Konsult Group do not guarantee its appropriateness or potential value. Since individual needs and risk profiles differ, we suggest that you consult your qualified financial adviser if necessary. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider (FSP 728).