Valuations matter, not just growth3 min read . Updated: 25 Dec 2007, 12:11 AM IST
Valuations matter, not just growth
Valuations matter, not just growth
The rationale for investing in emerging markets has been a simple one: they have higher GDP growth than their developed counterparts. Recent research by Citigroup Inc.’s Markus Rosgen, Elaine Chu and Chris Leung show that that’s too simplistic a view.
The Citigroup strategists say that high GDP growth doesn’t necessarily translate into high earnings growth. By way of example, they point out that the US outstrips both Europe and Asia ex-Japan in terms of compounded annual earnings growth since 1990. The surprise is that even Europe does better than the Asia ex-Japan region in earnings growth.
That's quite a surprise, but perhaps 1990 is too far back to make a fair comparison. Earnings growth in India and China today would surely be much higher. Rosgen says that markets value earnings, not GDP growth. That's obvious and he says that, in terms of market performance (MSCI data), the US is on top, followed by Europe and then Asia.
Really? The MSCI numbers show that the annualized historical return over the last 10 years has been: US 4.5%, the euro zone 8.9%, emerging markets 11.9%, emerging markets Asia 11.3% and India 20%.
Much depends, obviously, on the starting date for the comparison.
But there are a couple of other interesting observations in the Citigroup report. One of them says that it’s very difficult to predict earnings growth and even the best analysts have to revise their numbers.
Rosgen finds that the investor gets better returns if he buys on the basis of historical earnings record, rather than on the basis of earnings forecasts. The other point is that it’s better to buy companies with average growth than those with outstanding growth.
This seems counter-intuitive, but Rosgen says that high-growth companies are often over-valued, as everybody knows their stories. And finally, the note says that emerging markets stocks have outperformed developed markets when their valuations were lower and returns on equity higher than in the mature markets. Unfortunately, that’s not the case today. Rosgen says that on a price to book value basis, Asia ex-Japan is trading at a 9% premium to the MSCI World Index, while on a price-earnings multiple basis, the premium is 25%. However, the return on equity is at a 13% discount.
In spite of being hemmed in by all kinds of restrictions, India's foreign exchange markets have been doing rather well. That's the conclusion thrown up by data from the Bank for International Settlements.
The numbers show that, in 1998, India's foreign exchange market turnover accounted for 0.1% of global market turnover. By 2001, that went up to 0.2%. Three years later, that share increased by another 10 basis points to 0.3%.
Clearly, while India's market share of foreign exchange transactions was growing, it was doing so at a glacial pace and its share was woefully inadequate for a country of its size. During the last three years, however, India's share in foreign exchange turnover has gone up substantially and it accounted for 0.9% of global forex turnover.
Our global share is now higher than South Korea's, which is 0.8% and well above that of most other Asian countries. Of course, free trade zones such as Hong Kong and Singapore have much higher turnover, at 4.4% and 5.5% of the global foreign exchange market, respectively.
A big reason for the rise in India's foreign exchange turnover was the derivative market, with average daily volumes on forex derivatives including forex swaps rising from $4 billion in 2004 to $27 billion by 2007.
The introduction of currency futures, as recommended by the Committee on Fuller Capital Account Convertibility, should help increase volumes in the Indian market further. The country with the biggest share in global forex turnover was not the US, but the UK, which accounted for 34.1% of the world market. Moreover, it’s been gaining market share, which moved up from 31.3% in 2004.
In contrast, the US has been losing market share in forex, with its turnover declining from 19.2% of the world market in 2004 to 16.6% in 2007.
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