Beaten-down emerging equities may not be all that cheap
It’s generally accepted these days that emerging equities are cheap and that value-focused investors should consider buying. But some disagree — analysts at UBS say the alleged cheapness of EM equities rings hollow when you look at the return-on-equity on emerging companies. They don’t dispute that the market has de-rated significantly on price-earnings and price-book metrics (at 10.5 times and 1.5 times respectively, they are well below long-term averages). But they argue that these have not been excessive when compared to the decline in profitability. Emerging return-on-equity pre-crisis was usually higher than developed. Once at a lofty 17 percent, emerging ROE now languishes at 12.7 percent, almost on par with ROE for developed companies. Check out this graphic:
Multiples in EM have de-rated in only lock step with the de-rating in margins and RoEs relative to the developed world (UBS write)
UBS also point out, quite correctly, that not all emerging markets are cheap — while some indices such as Russia and China are indeed inexpensive, others such as Thailand, Philippines, Malaysia are very expensive. Sectors such as energy and materials, hostage to the global growth picture, are cheap but “outside of this, EM is not cheap; indeed even on a purely historical comparison it is expensive,” UBS says.
Lastly, the analysts compare EM stock valuations and country credit spreads. For the past decade these two have been mirror images — as credit spreads tightened, valuation multiples spiralled:
Now, with global liquidity set to wind down and emerging market fundamentals no longer improving, these credit spreads are unlikely to contract further and may even widen. There is bound to be an impact on equity valuations too, UBS analysts reckon. “EM will have to look beyond G10 liquidity to push up its multiples. That will have to come from sustained earnings and it will come from reform. On this count, EM doesn’t present itself as a winner,” they write.