Quick Bites | Where are share market valuations?

Forward Price Earnings Ratios

Source: Evans and Partners

It is always a good idea to keep an eye on fundamental valuation metrics and compare them with long-term averages. Markets tend to be mean-reverting, meaning that market returns and asset prices tend to revert to their long-term average measures. And during periods of heightened uncertainty, this can be especially useful in providing guidance.

So what are current share market valuations telling us? Forward price earnings (PE) ratios indicate that share markets are not expensive – or at least, not outrageously so. But there are a few caveats to be aware of:

1. If future earnings disappoint, then it could mean that markets are actually more expensive than thought.
2. Broad indexes are useful but hide what is going on “under the hood” – for example, some index components may be very cheap, and other sectors extremely expensive.
3. PE ratios overlook assets and liabilities of individual companies that might have material impacts on valuations, and other valuation metrics (such as the return on invested capital) may be better guides to a company’s value.

Nevertheless, forward PE ratios remain a useful metric for assessing whether markets are generally cheap or expensive. On my current reading of the charts above, markets look to be at reasonable levels.

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