How Expensive Are Global Stock Markets By Country Using Forward P/E Ratios?

I discussed valuations and the relationship to Japan’s 35 year bear market earlier this week. That discussion focused on Shiller CAPE Price to Earnings (P/E) ratios which look back 10 years and average earnings relative to the current prices of stocks.

The argument against a P/E ratio that looks backward is that companies can grow their earnings in the future in order to validate their higher price. This is obviously true, and it’s exactly what some of the higher growth companies, concentrated in U.S. technology, have done over the last 14 years.

The graph below looks at forward P/E ratios for different countries. Instead of looking backward, this takes current prices and projects them against future earnings. These P/E ratios are almost always lower than those that look backward because Wall Street analysts and companies (that make their money selling stocks) want them to look less expensive and more attractive. They do this by projecting strong future earnings growth. I do the same thing when selling commercial real estate (investors need to project income growth over the coming years in order to model returns).

Even using forward estimated P/E assumptions, this model gives you a view of countries that are expensive (red) and those that are inexpensive (green).

The problem comes when you’ve already priced in massive future growth (higher forward P/E ratios), and there is a speedbump along the way. The company has to deliver on the lofty projections.

The opposite occurs when you’re looking at inexpensive stocks or countries. If valuations are already low, and future earnings are projected to be low, any news that’s more positive to the upside can become a catalyst upward for prices.

I like to do the latter; buy companies and regions that are out of favor at low valuations. That may sound obvious, but that strategy has significantly underperformed over the last 14 years. The investors that purchased high projected growth expensive companies (technology) in expensive countries (the United States) have vastly outperformed almost everything else.