On an individual company level, it is common to evaluate the business fundamentals with the help of ratio analysis, with price-to-earnings and price-to-book as the most popular metrics used. Ratio analysis is less frequently applied to the overall stock market of a country.[mepr-active membership=”1734″ ifallowed=”show” unauth=”message” unauth_message=”Please login or purchase a membership to view full text.”]
We have plotted a valuation map for the different equity markets in Asia-Pacific. The vertical axis of the graph shows the CAPE ratio. The horizontal axis shows the price-to-book ratio. The size of the bubbles indicates the market capitalization in USD of each country.
The Cyclically Adjusted Price-Earnings (CAPE) ratio, also known as the Shiller or P/E10 ratio, sets the current price of a country’s market index in relation to the average inflation-adjusted earnings over the last ten years of the constituents companies in that index. The price-to-book ratio (PB) puts the price of a country’s market index in relation to the accumulated and averaged book values of all companies included in that index.
Although both indicators have limited predicting power over a short and mid-term period, they can nevertheless serve as an informative snapshot of the market condition in the country. Rather than an indication of potential returns in the future, the graph could provide some hints for downside risks inherent in these markets. The relevance of both indicators increases with the size of the market capitalization of the country.
According to the chart, we can see that China, South Korea, and Singapore are markets with currently a favorable valuation regarding CAPE and PB ratio. New Zealand, Philippines, India and Indonesia are on the other hand markets with a relatively high valuated markets that come with greater market risks.
While it can be a smart strategy to buy the overall market with an index fund in countries with a low valuation, it is wise to apply a carefully stock picking and timing strategy in overpriced markets.
The CAPE and other country valuation ratios are regularly published along with further research by Starcapital AG.
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