It’s taken me a while to get here, but in this, the last of my ten posts looking at publicly traded companies globally, I look at pricing differences across regions and sectors. I laid out my rationale for looking at pricing in my most recent post on the topic, where I drew a distinction between good companies, good management and good investments, arguing that investing is about finding mismatches between reality (as driven by cash flows, growth and risk) and perception (as determined by the market).
Multiple = Standardized Price
When looking at how stocks are priced and especially when comparing pricing across stocks, we almost invariably look at pricing multiples (PE, EV to EBITDA) rather than absolute prices. That is because prices per share are a function of the number of shares and are, in a sense, almost arbitrary. Before you respond with indignation, what I mean to say is that I can make the price per share decrease from $100/share to $10/share, by instituting a ten for one stock split, without changing anything about the company. As a consequence, a stock cannot be classified as cheap or expensive based on price per share and you can find Berkshire Hathaway to be under valued at $263,500 per share, while viewing a stock trading at 5 cents per share as hopelessly overvalued.
The process of standardizing prices is straight forward. In the numerator, you need a market measure of value of equity, the entire firm (debt + equity) or the operating assets of the firm (debt + equity -cash = enterprise value). If you confused about the distinction, you may want to review this post of mine from the archives. In the denominator, you can scale the market value to revenues, earnings, accounting estimates of value (book value) or cash flows.
As you can see, there is a very large number of standardized versions of value that you can calculate for firms, especially if you bring in variants on each individual variable in the denominator. With net income, for instance, you can look at income in the last fiscal year (current), the last twelve months (trailing) or the next year (forward). The one simple proposition that you should always follow is to be consistent in your definition of multiple.
The “Consistent Multiple” Rule: If your numerator is the market value of equity (market capitalization or price per share), your denominator has to be an equity measure as well (net income or earnings per share, book value of equity. For example, a price earnings ratio is consistent, since both the numerator and denominator are equity values, and so is an EV to EBITDA multiple. A Price to EBITDA or a Price to Sales ratio is inconsistent, since the numerator is an equity value and the denominator is to the entire business, and will lead to conclusions that are not merited by the fundamentals.
Pricing – A Global Picture
To see how stocks are priced around the world at the start of 2017, I focus on four multiples, the price earnings ratio, the price to book (equity) ratio, the EV/Sales multiple and EV/EBITDA. With each multiple, I will start with a histogram describing how stocks are priced globally (with sub-sector specifics) and then provide country specific numbers in heat maps.
The PE ratio has many variants, some related to what period the earnings per share is measured (current, trailing or forward), some relating to whether the earnings per share are primary or diluted and some a function of whether and how you adjust for extraordinary items. If you superimpose on top of these differences the fact that earnings per share reported by companies reflect very different accounting standards around the world, you can already start to see the caveats roll out. That said, it is still useful to start with a histogram of PE ratios of all publicly traded companies around the world:
Note that of the 42,668 firms in my global sample, there were only 25,493 firms that made it through into this graph; the rest of the sample (about 40%) had negative earnings per share and the PE ratios was not meaningful. While the histogram provides the distributions by regional sub-groups, the heat map below provides the median PE ratio by country:
If you go to the live heat map, you will also be able to see the 25th and 75th quartiles within each country, or you can download the spreadsheet that contains the data. I mistrust PE ratios for many reasons. First, the more accountants can work on a number, the less trustworthy it becomes, and there is no more massaged, manipulated and mangled variable than earnings per share. Second, the sampling bias introduced by eliminating a large subset of your sample, by eliminating money losing companies, is immense. Third, it is the most volatile of all of the multiples as it is based upon earnings per share.
Price to Book
In many ways, the price to book ratio confronts investors on a fundamental question of whether they trust markets or accountants more, by scaling the market’s estimate of what a company is worth (the market capitalization) to what the accountants consider the company’s value (book value of equity). The rules of thumb that have been build around book value go back in history to the origins of value investing and all make implicit assumptions about what book value measures in the first place. Again, I will start with the histogram for all global stocks, with the table at the regional level imposed on it:
The price to book ratio has better sampling properties than price earnings ratios for the simple reason that there are far fewer firms with negative book equities (only about 10% of all firms globally) than with negative earnings. If you believe, as some do, that stocks that trade at less than book value are cheap, there is good news: you have lots and lots of buying opportunities (including the entire Japanese market). Following up, let’s take a look in the heat map below of median price to book ratios, by country.
Again, you can see the 25th and 75th quartiles in either the live map or by downloading the spreadsheet with the data. Pausing to look at the numbers, note the countries shaded in green, which are the cheapest in the world, at least on a price to book basis, are concentrated in Africa and Eastern Europe, arguably among the riskiest parts of the world. The most expensive countries are China, a couple of outliers in Africa (Ivory Coast and Senegal, with very small sample sizes) and Argentina, a bit of a surprise.
EV to EBITDA
The EV to EBITDA multiple has quickly grown in favor among analysts, for some good reasons and some bad. Among the good reasons, it is less affected by different financial leverage