If I were an investor in China at the moment, I’d be feeling really gloomy.
That’s because stocks there seem to be really expensive – and buying highly valued shares is a great way to risk suffering a permanent loss on your capital.
Where things are pricey
An article adapted from asset management firm Schroders that was published in the Business Times yesterday spelled out the situation neatly:
“Although aggregate price-to-earnings (PE) multiples for the broader Shanghai A-share indices are “only” at 22 times today, well below the peaks reached in the last bubble in 2007 when they climbed to over 45 times, these headline numbers are dragged down by the large-cap banks.
Meanwhile, at a more granular level, over 70 per cent of individual stocks are now trading at multiples of over 50 times, while the ChiNext index, which represents small-cap growth stocks, is now valued at 95 times reported profit.”
Raging bull markets – like something China’s experiencing now – can continue for a long time even if stocks look expensive. But, it’s worth noting that the valuation that stocks carry and the amount of risk that investors face often trend together in the same direction.
It’s for this reason – that risks are amplified when valuations are high – that I’d likely find myself depressed if I were an investor in China. But fortunately for investors in Singapore, there are reasons to think that the situation’s very different.
Where things are cheap
As I wrote yesterday, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), ended 2014 with a Graham and Dodd PE (price-to-earnings) ratio of just 13.7, which is more than 30% lower than the index’s average Graham and Dodd PE of 20.8 from December 1985 to December 2014. (The Graham and Dodd PE is obtained by dividing a stock’s current price with its average earnings per share over the 10 past years; the rational for doing so is to smooth out the volatility of the business cycle).
With the Straits Times Index’s current level of 3,460 points being very close to where it was at end-2014, it’d likely be fair to say that the market benchmark’s current Graham and Dodd PE ratio will be very close to where it was at end-2014. In other words, the Straits Times Index has a valuation now that’s a fair bit lower than its long-term average.
Other valuation measures for the index also point to similar conclusions. The SPDR STI ETF (SGX: ES3) – an exchange-traded fund which closely mimics the fundamentals of the Straits Times Index – has a trailing PE ratio of 14 at the moment. This compares favourably with the Straits Times Index’s long-term average PE of 16.9 from 1973 to 2010.
These figures – the Graham and Dodd and the regular PEs – seem to suggest that stocks in Singapore have, at least, a fairly cheap valuation in aggregate.
A Fool’s take
In my article published yesterday that I referenced earlier, I cautioned:
“The annals of history may point toward the Straits Times Index as having a cheap valuation now, but that shouldn’t be applied to individual stocks. At any moment in time, individual stocks can offer vastly different risk/reward characteristics from that of the market. Keep this caveat in mind whenever you invest.”
So while there’d definitely be groups of individual shares in Singapore that look expensive now, what we’ve seen with the Straits Times Index can at least offer some solace that there’d likely be a nice swath of shares in Singapore which would be cheap.
For investors who are out looking for bargains, that’s something to be thankful for.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.