HOW EX­PEN­SIVE ARE EQ­UI­TIES AT THE MO­MENT?

Shares - - GREAT IDEAS UPDATES -

MANY IN­VESTORS LIKE to use Robert Schiller’s cycli­cally-ad­justed price-to-earn­ings (CAPE) ra­tio to gauge whether a mar­ket is cheap or ex­pen­sive.

It is the share price di­vided by the av­er­age of 10-20 years of earn­ings which in the­ory should help smooth out the im­pact of peaks and troughs in the busi­ness cy­cle.

Un­for­tu­nately this ra­tio may not be en­tirely suit­able to as­sess whether the mar­ket has got ahead of it­self.

Phillip Hoff­man, in­vest­ment direc­tor of Pzena In­vest­ments says the CAPE ra­tio has def­i­nitely been scream­ing over-val­ued for some time. How­ever, he makes the point the Schiller’s orig­i­nal work was only ever meant as an in­di­ca­tor of long term re­turns for the mar­ket. ‘I don’t think it was ever meant to be a short-term mar­ket tim­ing tool,’ he com­ments.

Duncan La­mont, head of re­search and an­a­lyt­ics at Schroders, last year said when the Shiller PE was high, sub­se­quent long term re­turns were typ­i­cally poor. ‘One draw­back is that it is a dread­ful pre­dic­tor of turn­ing points in mar­kets. The US has been ex­pen­sively val­ued on this ba­sis for many

years but that has not been any hin­drance to it be­com­ing ever more ex­pen­sive.’

Per­haps a bet­ter way to gauge the mar­ket’s val­u­a­tion is to look at for­ward PE ra­tios, namely how cur­rent share price match against earn­ings fore­casts for the next one and two years.

The FTSE 100 is cur­rently trad­ing on 14.09 times the cur­rent fi­nan­cial year’s earn­ings es­ti­mates ver­sus an ap­prox­i­mate av­er­age of 13-times over the past 15 years.

In com­par­i­son, the S&P 500 in the US cur­rently trades on 17.01-times ver­sus a his­tor­i­cal av­er­age of 15-times.

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