Is the growing valuation gap all it seems?
Australia Value Equity strategy
23 July 2018
Key points
- By some naïve measures, there is certainly evidence of a growing valuation spread, and greater valuation opportunities. But other quant measures are showing far narrower dispersions.
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We believe that naïve and quant measures miss a layer of fundamental insight required to truly understand the level of opportunity.
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By some measures, there is certainly evidence of a
growing valuation spread – the gap between the
cheapest and average-priced stocks in the market.
Wide valuation spreads have historically preceded
strong alpha for value strategies.
Most traditional Value indices (such as MSCI Value) are
predominantly based on relatively naïve measures such
as P/E or price to book (P/B). The divergence in P/E across investment styles that we have already
mentioned has caused the valuation spread based on
this measure to widen significantly.
Dispersions of P/B, another common indicator of
valuation opportunity, have also widen notably for the
Australian market.
Past performance is not a guide to future returns.
Source: Martin Currie Australia, FactSet; as at 30 June 2018.
However, a note of caution: other measures, which use
current earnings/cash flow based metrics and rely less
on a mean reversion assumption, are still showing far
narrower dispersions.
This is well
described by the valuation analysis of Empirical Research
Partners on the US market which uses cash flow methods.
This shows a much lower valuation spread, and as such,
less value opportunities available in the market than
shown by p/e or p/b measures.
Past performance is not a guide to future returns.
Source: Empirical Research Partners Analysis, National Bureau of Economic
Research; as at 31 May 2018.
While we agree Empirical Research Partners has a
comprehensive quantitative valuation model to assess
companies in the US and across the globe, we believe
both naïve and quant measures miss a layer of
fundamental insight required to truly understand the
level of opportunity.