Stock Picking Or Index Investing: Comparing Average And Median Price To Cash Flow Ratios Globally by Eric Bush, CFA, Gavekal Capital Blog

When looking at country level stock market valuation ratios, it is always useful to look both at median and average statistics. If you only look at average statistics, the resulting valuation ratios can sometimes be very skewed . When several companies are dramatically re-rated lower it drags down the average ratio statistics and can make an entire countries stock market look a lot cheaper than it actually is. A good example of this can been seen when looking at MSCI Brazil. The average price to cash flow ratio for MSCI Brazil is just 4.6x. If an investor just looks at this than one might think that market looks as cheap as it has at any point since 2009. However, the median price to cash flow ratio is still 8.6x which is right in the range that valuation ratios have been since mid-2012. Therefore, there most be a wide dispersion of valuations among individual stocks for investors to choose from. On the other hand, you have a situation like MSCI Hong Kong where the spread between average and median valuations is just 14 basis points. With average and median valuations so close, most likely there isn’t a lot of variation of valuation levels among individual stocks within the country index. In the charts below, we are going to group various country indexes into two baskets: large valuation spreads and small valuation spreads.

Index Investing

Index Investing

Large Spreads – Potential For Individual Security Analysis

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

Small Spreads – Index Investing May Make More Sense

19

20

21

22

23

24

25

26

27

28

29

30

Its tough to make an investment decision purely on valuation spreads. However, there are a couple of investment conclusions that I think we can make. First, when the spread between average and median valuations is large this means most likely that there is a wide dispersion of valuation levels among individual stocks within a country index. This would seem like an environment for stock pickers to be able to find opportunities to apply individual security analysis to unearth stock ideas. Second, when the spread between average and median valuation is small than it would seem that it would be tougher to find very many individual security ideas, at least from a relative valuation stand point, and investors would be better off buying or selling the entire country index (or ETF).