Kyle Caldwell, personal finance reporter at the Daily Telegraph, determined whether stock markets were undervalued or overvalued. Caldwell used three measures: price to earnings (P/E), cyclically adjusted price to earnings ratio (CAPE) and price to book (P/B). His analysis included 34 countries, both developed and emerging and compared current measures to historical averages.

We at ValueWalk believe that buying at low prices is crucial to investment success. All measures used need to be low relative to historical averages and other countries for a country to be considered undervalued. Using the P/E captures what the market believes a country’s stock earnings are worth.

The CAPE adjusts for cyclical variations and takes a longer term view than the P/E considering the earnings average over the last 10 years instead of the 12 month average. Its premise is that eventually earnings will move back to their long term trend. Price to book divides the current value per share over the equity value shown in the company’s balance sheet. The latter includes the value of buildings, intangible assets and other assets if they were to be liquidated. Price to book helps analysts adjust for any distortion caused by companies overstating earnings.

Stock Markets: Only a few countries are undervalued

Caldwell’s analysis uncovered only a few countries that traded below their historical averages and at undervalued levels relative to their peers. These are China, Greece, Hong Kong, India, Japan, Russia and Turkey. Some of these countries are undervalued because of political or financial unrest including Turkey, Russia and Greece. However, the others are attractive while not having high geopolitical or economic risk. Exchange traded funds (ETFs) are an undervalued way to get exposure. Ishares by BlackRock, Inc. (NYSE:BLK) offers a broad lineup of single country ETFs.

Stock Markets
Stock Markets Outlook Source: Daily Telegraph

Stock Markets: U.S. is pricey along with other emerging markets

By all three measures, the U.S. is expensive. This is likely due to indices such as the Dow Jones Industrials and the S&P 500 reaching record highs and consistent performance after the 2008 financial crisis. Josh Wright, Bloomberg economist and Brian Barnier, strategist at ValueAdvisors, LLC agrees in a Bloomberg Briefs report, that the current CAPE level of 26.2 is high relative to its long term median and its long term average. While it is still below peak levels reached during the 2000 dotcom bubble, it is concerning.

Another measure that Barnier and Wright use is the “strain gauge” or comparison of U.S. firms’ values against their contribution to U.S. GDP. The measure comes in at 2.89, considerably above its long term median and average. Barnier and Wright also calculated the price to sales of U.S. firms, which considers overseas activities that do not add to U.S. GDP. The measure is at its highest level since the dotcom bubble and in Barnier’s and Wright’s assessment shows that profits have been driven more by cutting costs than by revenue growth.

Stock Markets Equity

Other countries that are expensive are Sri Lanka, Pakistan and Indonesia. Recent outperformance has increased valuation ratios, which present a premium relative to potential gains.