The great cheapening of 2018: Global stock valuations now at 5-year lows

  • By Mike Bird,
  • The Wall Street Journal
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The stumble in global equity markets this year has outrun a moderation in expectations for earnings growth, leaving stock valuations at their cheapest in about half a decade by some measures.

What’s happening

The forward price to earnings ratio for global stocks is at five-year lows, having dropped to about 13.3 times. That’s down from more than 16 times in early 2018, according to FactSet’s World stock index, which includes tens of thousands of listed securities around the world.

The price to earnings ratio is a favorite among analysts and investors for valuing companies.

Valuations for some blue-chip stocks have plumbed multiyear lows: Japan’s Honda Motor Co. (HMC) and U.S. computing giant International Business Machines Corp. (IBM), for example, have both seen their PE ratios fall to around 10-year lows this quarter.

On one alternative, price to free cash flow, which measures the money a company has generated after operating expenses and capital spending, the trend is even more clear. By that measure, stocks are the cheapest they have been since early 2012, when the eurozone sovereign debt crisis was still raging.

Though price to earnings ratios have fallen in the U.S., the sharpest proportional declines have come from Europe and China.

The pullback reflects the fact that for all the choppiness in asset markets this year, expectations for earnings growth are still solid. Earnings-per-share of stocks listed on FactSet’s World Index are expected to rise about 15.9% in the next 12 months.

That’s down from the highs of above 25% earlier this year, but well above the 5.8% average seen in the past five years.

What it means

Company valuations can’t be looked at on their own. Rising bond yields mean stocks may be cheaper for a reason: Investors can access a higher risk-free return from ultrasafe government bonds than before, making equities less attractive in general for conservative investors.

Many asset managers have waxed lyrical during the current selloff about the valuation opportunities emerging, but the continued fall in world stocks through the fourth quarter suggests they’re not yet in the majority.

“Within Asia, we see most of the emergence of value coming from a couple of places. One is China,” said Louis Lau, director of investments at Brandes Investment Partners, who said he had added to his holdings of Chinese banks. He said they were hoping for another 5% to 10% pullback to get more excited about valuations in the Asian region.

Despite the cross-border slump in valuations, the fact that U.S. stocks remain more expensive than their peers elsewhere in the world is making some investors cautious.

“I am more constructive on the prospects for European, U.K., and Asian markets over the next few years in regard to their ability to generate returns,” said Nick Mustoe, one of Invesco’s chief investment officers.

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