OQFM calculates market earnings multiples based on the inverse of aggregate stock earnings yields. The PE ratio is a flawed valuation measure for companies with negative EPS and companies whose EPS are close to zero. An investable stock universe is used which comprises all companies which are covered by at least two analysts and have daily market turnover greater than $US0.5m. Three measures of “central tendency” are used: mean, median and weighted mean (based on the natural log of market capitalisation). The 12-month trailing earnings multiple for the key countries in the Fund’s universe as the end of March 2021 are shown in Chart 1.
Chart 1: Trailing Market Earnings Multiples
Source: OQFM
The trailing PE data partially reflect the extreme market environment during the Covid pandemic, particularly for tourism and leisure stocks. This can be addressed by looking at one-year forward pro-rated market multiples (Chart 2).
Chart 2: One Year Forward Market Earnings Multiples
Source: OQFM
It is interesting to note how high the one year forward market multiples are for all markets except China/HK, with most multiples, regardless of the measure of central tendency, being above 15. This is despite the fact analysts are consistently too bullish with their forecasts – this has been the case since I started doing quant factor research in the mid-1990s. Further, analysts are currently embracing the reflation thematic and high growth scenarios for technology companies, potentially exacerbating this problem.
Put differently, the earnings estimates underpinning the already elevated forward market multiples are almost certainly too high. Given this, it is potentially risky having too much market beta in portfolios, especially in countries where stocks are priced to perfection.
While it is interesting to note the relative cheapness of China/HK, the aggregate earnings multiple masks the extreme valuation spreads across Chinese stocks. Focusing solely on expensive stocks tells a different story. Chart 3 shows the weighted average earnings yield for all stocks with a one year forward earnings yield half a standard deviation below the mean. (Note: the chart shows earnings yield data as the PE ratio for Australia is not meaningful).
Chart 3: One Year Forward Earnings Yield One Std Dev Below Average
Source: OQFM
Expensive Chinese stocks aren’t noticeably cheaper than expensive stocks in other markets. This implies that cheap stocks in China/HK are extremely cheap, both absolutely and relatively, and indeed this is the case. Chart 4 shows the weighted average earnings yield for all stocks with a one year forward earnings yield half a standard deviation above the mean.
Chart 4: One Year Forward Earnings Yield One Std Dev Above Average
Source: OQFM
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