MSCI bets make Saudi stocks pricey

Saudi shares up 14% this year, with bourse’s capitalisation now more than South Africa’s

Emerging-market investors need deeper and deeper pockets as they prepare to add stocks from the largest exchange in Africa and the Middle East to their portfolios.

Saudi Arabian shares have climbed 14 per cent this year, partly as foreign investors bet the country will win upgrades to emerging-market status, which they expect to trigger billions of dollars of inflows from funds tracking global benchmark indexes.

The buying has pushed the capitalisation of Riyadh’s market beyond that of South Africa in dollar terms for the first time in 11 months. As the gains pile up, Saudi stocks have become more expensive than the group the country is poised to join.

Saudi Arabian shares have historically traded at a premium to the average for emerging markets, as access was largely restricted to local investors until three years ago. But Saudi price-to-earnings estimates for the next 12 months are near the widest gap over developing countries since 2015.

Index compiler MSCI Inc. will announce a decision on whether to add the kingdom to its emerging-markets indexes on June 20, while FTSE Russell made the call in March and will implement it next year.

“After the recent rally, I’d be cautious on going into Saudi on a broad basis,” said Osama Al Owedi, head of investment management at GIB Capital LLC in Riyadh. “Valuations are already on the higher side, and growth potential is not so high to justify this. Dispersion in valuations is very high, especially for candidates that are expected to have large inflows from index inclusion, with many of them already trading at high levels.”

While expectations around the results of index inclusion are widely positive, the optimism isn’t matched in the Saudi economy.