Gavekal Capital: No Matter How You Slice It, Stocks Everywhere Are Just Downright Expensive, Especially in DM

It's no secret that we think stocks are expensive. Indeed, over the last few months we've written extensively about what we think are high valuations for stocks everywhere. See Are EM Asia Equities Really That Cheap?, Navigating High Stock Valuations in a Deflationary World, Valuation Update: Stocks are (Still) Expensive Everywhere, Stocks Selling at a Discount to Book Value is a Thing of the Past, and Stock Valuations Jumped Again in December.

Along those same lines we thought we'd provide an update on valuations with data through February, only we'll take a slightly different tack. In this post we will show stock valuations from three different perspectives:

Median price to cash flow based on trailing data
Normalized median price to cash flow based on the five year average cash flow
Forward market capitalization weighted price to cash flow

We've chosen to show the price to cash flow because the denominator, cash flow per share, is much harder for companies to manipulate than EPS. Also, we've chosen these three metrics for very specific reasons. The median ratio is by definition not market capitalization weighted and thus filters out distortions created by a small group of extremely large stocks. Normalized valuations smooth out fluctuations in the denominator caused by boom and bust years, thus giving a clearer sense of cash flow generation over the course of the business cycle (though 2008-2009 cash flow would have dropped off by now). Finally, forward market cap weighted valuations incorporate analyst estimates of future cash flow and also the distortions created by large stocks. We think there are many flaws with market cap weighted valuations based on forward estimates, but the world looks at them and so we do, too.

For each of the three valuation metrics listed above we'll show the ratio for all six of the MSCI developed market and emerging market regions - Pacific, Europe, North America, EM Asia, EM EMEA, and EM Latin America.

The conclusion we come to is fairly simple. Stocks are expensive pretty much everywhere you look. Stocks in developed markets are more expensive relative to their own history than stocks in emerging markets, but stocks in EMs can hardly by called great values. That point is especially true when looking at the median price to cash flow, which shows the median EM stocks trading at levels near or higher than the 2007 peak. Furthermore, as we noted in Are EM Asia Equities Really That Cheap? the cheap stocks in the EMs are exactly the ones you want to avoid for structural reasons.

Median Price to Cash Flow